History

Synergy Manufacturing is a privately held maker of electronic components used in the assembly of consumer products. The company enjoys respectable profitability and has historically posted pre-tax annual income in the 18-19% of gross sales range. Material costs have generally remained at levels of 44-45% of gross sales. Ownership plans to sell the company to a larger electronics firm sometime over the next two years. Company leadership believes that maintaining profitability in this 18-19% of gross margin range will help make the company an attractive acquisition target.

Scenario #1: The sales manager of your company presents you with an opportunity to gain $2,000,000/year in new business from a single customer. This new customer will order in large quantities of a single item. At issue is the fact that the sales price needed to obtain this new business will require a significantly higher cost in materials than the companys overall book of business. Specifically, on the companys 2020 income statement, material costs were 45% of sales. The pricing structure necessary to secure this additional business will require that material costs represent 62.5% of the sale. In other words, the additional $2,000,000 in sales will require $1,250,000 in materials.

Discussions with manufacturing, administration, customer service, and sales reveal that the company can absorb this level of business without incurring any additional fixed cost.

Scenario #2: The sales manager of your company presents you with an opportunity to gain $3,000,000/year in new business from a single customer. At issue is the fact that the sales price needed to obtain this new business will require a higher cost in materials than the companys overall book of business. The pricing structure necessary to secure this additional business will require that material costs represent 60% of the sale ($1,800,000).

Discussions with manufacturing, administration, customer service, and sales reveal that the company will need to invest in capabilities to handle this additional $3,000,000 in business.

Manufacturing reports that it will be necessary to purchase new equipment. Depreciation expense for this new equipment will be an additional $75,000 per year. Two new equipment operators (direct labor) at $75,000 each per year will be needed as will two new indirect laborers at $45,000 each per year. Payroll taxes will cost about 7.25% of salaries for these new hires. Additionally, the company provides a full range of benefits for all employees.

Human resources advises that the cost of the benefit package is 20% of each employees salary (e.g., if an employee earns $45,000 per year, the cost of the provided benefit package is $9000).

Customer service reports that two new customer service representatives will be required to handle the influx in new business. Salaries for these new hires will be $40,000 each plus applicable payroll and benefit expenses.

The Sales department says that this particular customer requires quite a bit of attention. Multiple visits each year will cost about $50,000 in travel expense.

Sales also reports that this particular customer will order multiple times each day and will order multiple items. The resulting number of invoices and accounts receivable postings will require two new administrative personnel at a cost of $40,000 each plus payroll tax and benefit expenses. The administrative department advises that an additional $27,000 per year will be needed for general office supplies.

Using the example worksheets, develop proforma income statements for each scenario. Determine which one provides the greatest level of company benefit and explain why.