Table of Contents Case Overview .. Problem Statement . Cost-Volume-Profit Analysis.. .3 Present scenario: The agents commission rate remains unchanged at 15%.. .3 Alternative-1: The agents commission rate is increased to 20%.. .5 Alternative-2: The company employs its own sales force.. Comparative Analysis & Recommendation 10 Comparative Analysis. 10 Recommendation. 12 Reference. 13 Appendix ...... ..... 14The higher margin of safety, the better it is. But if Pitman employs its own Sales force then there will be lower margin of safety compared to the other alternative. Which may affect profit if cost rises anyhow? Margin of safety has decreased to $1000000 from $2285714. It has decreased by $1285714 from the condition if they give 20% commission to the agents. Cost Structure, Break Even and Target Profit Analysis: Pittman Company CaseComparative Analysis & Recommendation Comparative Analysis Based on the cost-volume-profit analysis, we have done a comparative analysis of the important measures. Own Sales Force $332,500 20% Commission Rate $560,000 15 % Commission Rate $1,120,000 $0 $400,000 $800,000 $1,200,000 Net Income It is shown that Net Income of Pittman Company is highest when the company uses 15% Commission rate. Under 20% Commission rate structure net income is $560,000. When company use its own sales force its Net Income is lowest ever which is $332,500. 47.5% Own Sales Force 20% Commission Rate 35% 15% Commission Rate 40% 0 0.1 0.2 0.3 0.4 0.5 CM Ratio CM Ratio of Pittman Company is highest when it uses its own sales force, which is 47.5%. CM ratio at 15 % commission rate is 40% which falls to 35% when commission rate increases to 20 %. Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case 10Own Sales Force 15,000,000 20 % Commission Rate 13,714,286 15% Commission Rate 12,000,000 0 5000000 10000000 15000000 20000000 Break Even Point (Dollar Sales) Break even in dollar sales is highest when company use its own sales force. It is lowest under 15 % commission rate structure. If commission rate becomes 20% its Break-even point increases $13,714,285 from $12,000,000. And if the company employs its own Sales force then the Break-even in dollar sales increases to $ 15,000,000. Own Sales Force 16 15 % Commission Rate 15 % Commission Rate 4 0 5 10 15 20 Operating Leverage Operating leverage has increased to 16 from 7 if it use own sales force rather than sales agents. It is 9 times more than the Operating leverage when the company gives 20% commission. This implies that Pittman Company's net operating income is more sensitive to changes in volume of sales compared to the alternative under which the firm pays 20% commission to sales agents. Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case 11Own Sales Force 1,000,000 20% Commission Rate 2,285,714 15% Commission Rate 4,000,000 0 2000000 4000000 Margin Of Salety (Dollar) The margin of safety is higher when company uses sales agents at 20% commission rate rather than own sales force which is $2,285,714 and $1,000,000 respectively. The margin of safety percentage is 14.29% and 6.25% when company pays 20% commission rate and uses its own sales force respectively. Recommendation The company should continue with sale agents on 20% commission because in that case it will earn more profits and breakeven sales Is also lower as compared to other option so it will be easy for them to reach no loss no profit situation. Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case 12Reference . Garrison, R., Nowreen, E. and Brewer, Managerial Accounting. 15th ed. McGraw- Hill Education. Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case 13Appendix Case 5-33: Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies completely on independent sales agents to markets its products. These agents are paid a sales commission of 15% for all items sold. Karl Vecci, Pittman's controller, has just prepared the company's budgeted income statement for next year. The statement follows: Pittman Company Budgeted Income Statement For the year ended December 31 Particulars Amount ($) Sales 16000000 Manufacturing expenses: Variable 7200000 Fixed overhead 2340000 Total Manufacturing Expense 9540000 Gross Margin. 6460000 Selling and Admin expenses: Commissions to agents 2400000 Fixed marketing expenses.. 120000 Fixed admin expense 1800000 Total Selling and Admin Expense 4320000 Net operating Income 21 40000 Fixed interest expenses 540000 Income before Income taxes 1600000 Incomes taxes (30%) 480 000 Net income 1120000 *Primarily depreciation on storage facilities This statement was made using agents 15% commission rate, but next year will increase to 20%. Several companies they know about pay a 7.5% commission to their own salespeople, along with a small salary. Of course, they have to handle promotional cost, too. They figure their fixed expenses would increase by $2,400,000 per year, but that would be more than offset by the $3,200,000 (20% X $16,000,000) that they would avoid on agents' commissions. The breakdown of the $2,400,000 cost follows: Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case 14Salaries $111100!) Sales manager EDIMDD Salespersans 400,000 Travel and entertainment Litm Advertising Total $2.41!], "Super\-use income BEFORE income taxes in your operating leverage computation 5.) Based on the data in (1) through (4) above, make a recommendation as to whether the company should continue to use sales agents (at 20% commission rate) or employ its own sales force. Give reasons for your answer. Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case 16Case Overview Pittman Company is a small manufacturer of telecommunications equipment growing at a decent rate. The firm has no sales force of its own. So it relies on independent sales agents for the marketing of its products. At present the company pays a commission rate of 15% tor the sales agents. However, the sales agents are now refusing to market Pittman's products unless the firm increases the commission rate to 20%. This has been a trend in the recent years, sales agents asking for higher commission rate. Pittman's president views this demand as going beyond the line although the agents claim that after paying for advertising, travel, and the other cost of promotion, there's nothing left over for profit. Thus, Pittman Company is planning to dump its sales agents use its own sales force to market its product. Barbara Cheney, Pittman's controller, has just prepared some figures based on this plan. They searched for information about what other companies pay to their sales people as commission. They found several companies pay 7.5% commission to their sales people, along with a small salary. Additional they would have to handle all promotion costs too. They figured that fixed expenses would increase by $24,00,000 per year, but would be more than to offset by the $32,00,000 (20% X $16,000,000) that they would go avoid of sales agents. They noticed that $24,00,000 is just what they are paying to agents under the present 15% commission rate. They also found that they can save an additional $75,000 a year because they would not require outside auditing firm that they required to check the sales agents. So, cost-volume-profit analysis is required to evaluate these alternatives and find out which alternative is best for Pittman Company; whether they should a) they should continue to use sales agents. Problem Statement What are the sales channel alternatives that are available to the firm? What are the factors to which net income of the firm is most sensitive to? . What amount of dollar sales the firm must earn to break even under each alternative? What amount of degree of operating leverage the firm should expect to have on December 31 of the corresponding year? . What is the expected margin of safety of the company under each alternative? Cost Structure, Break Even and Target Profit Analysis: Pittman Company Case- What alternative should the firm undertake to market its product? Should the firm increase the sales agents commission rate to 20% to secure the services of independent sales agent to market its products or should the firm employ its own sales force? Cost Structure, Break Even and Target Profit Analysis: Pittman Company CaseCost-Volume-Profit Analysis Present scenario: The agents commission rate remains unchanged at 15% The firm at present has no sales force of its own and thus relies on independent sales agents for the marketing of its products. The company currently pays a commission rate of 15% tor the sales agents. Here we have analyzed and evaluated the cost- volume-profit aspects of Pittman Company when it agents commission rate remains at 15%. Pittman's Income Statement when the agents commission rate remains unchanged at 15% Pittman Company Budgeted Income Statement For the year ended December 31 Particulars Amount ($) Sales $16,000,000 Manufacturing expenses: Variable 7,200,000 Fixed overhead 2,340,000 Total Manufacturing Expense 9,540,000 Gross Margin. 6,460,000 Selling and Admin expenses: Commissions to agents 2,400,000 Fixed marketing expenses.. 120,000 Fixed admin expense 1,800,000 Total Selling and Admin Expense 4,320,000 Net operating Income 2,140,000 Fixed interest expenses 540,000 Income before Income taxes 1,600,000 Incomes taxes (30%) 480,000 Net Income $1,120,000 From the above statement we can see that, the firm's net income under 15% commission rate structure is $1,120,000. The commissions paid to agents' equals $2,400,000. Break-Even point In dollar sales: The agents commission rate remains unchanged at 15% Total Fixed Cost $4,800,000 Total Variable Cost 9,600,000 Contribution Margin 6,400,000 Contribution Margin Ratio 0.4 Break Even in dollar Sales $12,000,000 Cost Structure, Break Even and Target Profit Analysis: Pittman Company CaseContribution margin is the amount remaining from sales revenue after variable expenses have been deducted. It is the amount available to cover fixed expenses and then to provide profits for the period. The contribution margin for Pittman Company is $ IEJJDIJJZHJU and thus the amount which is available to Pittman Company to cover for fixed expense and to provide for prots after covering its variable expenses. The contribution margin as a percentage of sales is referred to as the contribution margin ratio. The CM ratio shows how the contribution margin will be affected by a change in total sales. Thus contribution margin ratio from Pittman company when agents commission rate remains at 15% is 40%. The breakeven point is as the level of sales at which the company's profit is zero. Once the break-even point has been reached, net operating income increases by the amount of excess amount of sales revenue. The breakeven point in dollar sales for Pittman Company when agents commission rate remains at 15% is $12,D,i)[i. So; the company has to generate sales revenue worth $lliiii to break even where it profits are equal to its costs. Dpereting Leverage The company employs Its own sales force 4.0-0 Percentage change In net operating Income Operating Leverage is a measure of how sensitive Net Operating Income is to a given percentage change in dollar sale. Operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in sales can produce a much larger percentage increase in net operating income. The degree of operating leverage for Pittman Company is 4 when the commission rate of agents remains at 15%. The company's net operating income therefore grows four times as quickly as its revenues. Thus, net operating income will boost by 441] percent {4 times greater} if sales increase by 1|) percent. Hergln ofetety Margin oI safety In dollars $4,onn,onn Margin or safety percentage assess Margin of safety is the excess of budgeted or actual sales dollars over the breakeven volume of sales dollars. It is the amount by which sales can drop before losses are incurred. The higher the margin of safety, the lower the risk of not breaking even and incurring a loss. The margin of safety in dollars for Pittman Company when agents commission rate remains at 15% is $4,0CHJ,EHJD and margin of safety under 15% commission structure is 25%. This margin of safety means that at current level of Cost Structure, Brook Evan and Taryn-i Profit docile-sis: Pittman Componv for c -'i sales and with the company's current prices and cost structure, a reduction in sales of $4000000 or 25% would result in just breaking even. Alternative-1: The agents commission rate is increased to 20% One alternative that is available to Pittman is use the existing sales agent by paying them 20% commission rate, which reflects a 5% increase in commission rate. The alternative has been analyzed and evaluated here using cost-volume-profit analysis tools. Pittman's Income Statement when the agents commission rate is Increased to 20% Pittman Company Budgeted Income Statement For the year ended December 31 Particulars Amount ($) Sales $1,6000,000 Manufacturing expenses: Variable 7,200,000 Fixed overhead 2,340,000 Total Manufacturing Expense 9, 540,000 Gross Margin. 6,460,000 Selling and Admin expenses: Commissions to agents 3,200,000 Fixed marketing expenses.. 120,000 Fixed admin expense 1,800,000 Total Selling and Admin Expense 5, 120,000 Net operating Income 1,340,000 Fixed interest expenses 540,000 Income before Income taxes 800,000 Incomes taxes (30%) 240,000 Net income $560,000 When the agents commission rate increase to 20%, commissions to agents' increases to $3,200,000 from $2,400,000. This ultimately affects the net income of the firm. The firm's net income under 20% commission rate decreases to $560,000 from $1,120,000. Income before income taxes also decreases and as a result the company has to pay less in taxes. Cost Structure, Break Even and Target Profit Analysis: Pittman Company CaseBreak-Even point in dollar sales: The agents commission rate is increased to 20% Total Fixed Cost $4,800,000 Total Variable Cost 10,400,000 Contribution Margin 5,600,000 Contribution Margin Ratio 35% Break Even in dollar Sales $13,714,285.71 Contribution margin ratio of the firm drops when agents are paid a commission rate of 20%, which indicates that the company has a smaller amount available to cover fixed expenses and the amount that provides profit also gets reduced. The company's contribution margin under 20% commission rate is $560,000 which is less then contribution margin of $640,000. Thus contribution margin ratio drops to 35% from 40%. The break-even point in dollar sales increases to $13,714,285.71 from $12,000,000. Thus when sales agents commission rate is increased to 20%, break-even point in dollar sales increase by $1,714,285.71 ($13,714,285.71- $12,000,000). So, the company has to increase its sales or reduce its other costs when it pays 20% to agents to reach its target net income. Operating Leverage The company employs its own sales force 7.00 Percentage change in net operating income For Pittman Company degree of operating leverage is 7 when the agents commission rate is increased to 20% compared to operating leverage of 4 that it has when it pays 15% commission to sales agents. So the firm net operating income grows 7 times as fast as its sales. Thus if sales increase by 10%, net operating income will increase by 70% (7 times higher). The higher degree of operating leverage in the case of 20% commission rate is due to the higher commissions paid to the agents than in the case of 15% commission rate. So, the difference can be attributed to the cost structure under both the scenarios. Margin of Safety Margin of safety in dollars $2,285,714 Margin of safety percentage 14.29% The margin of safety in dollars for Pittman Company is $2,285,714 under 20% commission rate structure, which less than $4,000,000 margin of safety in dollars under 15% commission rate structure. The margin of safety percentage under 20% Cost Structure, Break Even and Target Profit Analysis: Pittman Company Casecommission rate structure is thus also less than under 15% commission structure. The Margin of safety under 20% commission rate structure is 14.29 %compared to 25% under 15% commission structure. Therefore, the firms risk of not breaking-even or incurring loss increases when it pays 20% commission rate to the sales agents. Alternative-2: The company employs its own sales force Last alternative to market Pitman Company's product is to use their own Sales force. By using their own Sales force, they think that they can minimize the cost of agents. Using their own Sales force means they will not take the help of any agent to market their products instead they will appoint their own sales personnel to complete the task. They will offer the sales personnel a fixed salary as well as 7.5% commission from sales. As agents are demanding more commission they want to take their own Sales force as an alternative thinking that it may minimize their costs and keep their profit at least where it is now. So in this case Pitman Company may offer their sales personnel a fixed salary and 7.5% commission on sales as found through research on other firms' sales force structures. Sales revenues are assumed to remain same. Pittman's Income Statement when the company employs its own sales force Pittman Company Budgeted Income Statement For the year ended December 31 Particulars Amount ($) Sales $16,000,000 Manufacturing expenses: Variable 7,200,000 Fixed overhead 2,340,000 Total Manufacturing Expense 9,540,000 Gross Margin. 6,460,000 Selling and Admin expenses: Commissions to agents 1,200,000 Fixed marketing expenses... 2,520,000 Fixed admin expense 1,725,000 Total Selling and Admin Expense 5,445,000 Net operating Income 1,015,000 Fixed interest expenses 540,000 Income before Income taxes 475,000 Incomes taxes (30%) 142,500 Net Income $332,500 Cost Structure, Break Even and Target Profit Analysis: Pittman Company CaseFrom the above statement we can see that Net income actually decreases compared to net income we got in case of and 20% commission structure. Furthermore, Net income is even less than what the net income will be after giving 20% commission to the agents. This decrease in sales is largely due to the extended fixed marketing expenses as the firm would now have to handle all promotion costs too. Break-Even point In dollar sales: The company employs its own sales force Total Fixed Cost $7,125,000 Total Variable Cost 8,400,000 Contribution Margin 7,600,000 Contribution Margin Ratio 17.5% Break Even in dollar Sales $15000000 Contribution margin ratio of the firm rises when Pitman creates its own Sales force; the company's contribution margin under its own Sales force alternative is $7,600,000 which is more than contribution margin of $5,600,000. Thus contribution margin ratio rises to 47.5% from 35%. Now if we notice Break Even point in Dollar sales we can see that the break-even point in dollar sales has increased, which is not profitable. The Break-even dollar sales have increased to $15,000,000 from $13,714,285.71. Break even dollar sales has been increased by $1,285,714.3 from the break-even dollar sales when Pitman pays 20% commission to its agents. It means it will take long to reach the break even and profit will be less if we target existing profit level. Operating Leverage The company employs its own sales force 16.00 Percentage change in net operating income Operating leverage refers to the sensitivity of change in net operating income (income before tax) to change in sales. It is not good if it is higher. Operating leverage has increased to 16% from 7%. It is 9% more than the Operating leverage when the company gives 20% commission. As in this case operating leverage is more which is 16% it means for 1% change in sales net operating income will change to 16%. If there is 1% increase in sales, then there will be 16% increase in net operating profit before tax. But if there is 1% decrease in sales then there will be 16% decrease in net operating income before tax. Margin of Safety Margin of safety in dollars $1,000,000 Margin of safety percentage 6.25% Cost Structure, Break Even and Target Profit Analysis: Pittman Company CaseCost Structure; Break-Even and Target Prot Analysis (10 marks) Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies completely on independent sales agents to market its products. These agents are paid a sales commission of 20% for all items sold. Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for next year. The statement follows: Pittman Company Budgeted Income Statemert For the Year Ended December 31 Sales ........ . ................. $16,000,000 Manufacturing expenses: Variable ...................... $7,200,000 Fixed overhead ................ 2,340,000 9,540,000 Gross margin .................... 6,460,000 Selling and administrative expenses: Commissions to agents .......... 2,400,000 Fixed marketing expenses ........ 120,000' Fixed administrative expenses . . . . 1,800,000 4,320,000 Net operating income .............. 2,140,000 Fixed interest expenses ............ 540,000 income before incometaxes ........ 1,600,000 income laces (30%) .............. 480,000 Net income ..................... 3 1,120,000 \"Primarily depreciation on storage faciiities. As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, \"I went ahead and used the agents\" 20% commission rate in completing these statements, but we've just learned that they refuse to handle our products next year unless we increase the commission rate to 25%.\" \"That's the last straw,\" Karl replied angrily. \"Those agents have been demanding more and more, and this time they've gone too far. How can they possibly defend a 25% commission rate?\" \"They claim that after paying for advertising, travel, and the other costs of promotion, there's nothing left over for profit,\" replied Barbara. \"I say it's just plain robbery,\" retorted Karl. \"And I also say it's time we dumped those guys and got our own sales force. Can you get your people to work up some cost gures for us to look at?\" \"We've already worked them up,\" said Barbara. \"Several companies we know about pay a 7.8% commission to their own salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would increase by $4,040,000 per year, but that would be more than offset by the $5,050,000 (25% x $20,200,000) that we would avoid on agents' commissions.\" The breakdown of the $4,040,000 cost follows: Salaries: Sales manager S 240000 130000 Salespersons 0 Travel and entertainment 960,000 1 540 00 Advertising ' ' 0 4 040 00 Total ' ' 0 \"Super,\" replied Karl. \"And I noticed that the $4,040,000 is just what we're paying the agents under the old 20% commission rate.\" \"It's even better than that,\" explained Barbara. \"We can actually save $145,000 a year because that's what we're having to pay the auditing rm now to check out the agents\" reports. So our overall administrative costs would be less.\" \"Pull all of these numbers together and we'll show them to the executive committee tomorrow,\" said Karl. \"With the approval of the committee, we can move on the matter immediately.\" Required: 1. Compute Pittman Company's break-even point in dollar sales for next year assuming: a. The agents' commission rate remains unchanged at 15%. b. The agents' commission rate is increased to 20%. c. The company employs its own sales force. 2. Assume that Pittman Company decides to continue selling through agents and pays the 20% commission rate. Determine the volume of sales that would be required to generate the same net income as contained in the budgeted income statement for next year. 3. Determine the volume of sales at which net income would be equal regardless of whether Pittman Company sells through agents (at a 20% commission rate) or employs its own sales force. 4. Compute the degree of operating leverage that the company would expect to have on December 31 at the end of next year assuming: a. The agents' commission rate remains unchanged at 15%. b. The agents' commission rate is increased to 20%. c. The company employs its own sales force. Use income before income taxes in your operating leverage computation. 5. Based on the data in (1) through (4) above, make a recommendation as to whether the company should continue to use sales agents (at a 20% commission rate) or employ its own sales force. Give reasons for your answer. (CMA. adapted)