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IDIS 424
VALUE OF PURCHASING
Spring 2004
• How will the company compete in a changing competitive environment?
• How companies make money:
Raise Prices
INCREASE REVENUE
Increase Volume
Reduce Personnel (downsize)
DECREASE COSTS Reduce process waste cost
Reduce materials cost
OPTION 1:
INCEASE REVENUE KEEPING COSTS STEADY– Not easy. Number of lower-priced, higher-quality products is always
increasing
OPTION 2: (More proactive)
REDUCE COSTS AND PASS THE SAVINGS TO THE CUSTOMER WHILE PRESERVING A PROFIT MARGIN AND MAINTAING RETURN TO SHAREHOLDERS
– First reaction: Reduce workforce size
– Next: Reengineering processes (identify & attack non-value-added activities)
– System integration, System simplification, Standardization, Performing processes in parallel, increased automation etc.
Increasing Price
Scenario Analysis
• If we increase Net Sales (selling price) by 1%, how do you think this will affect our Net Profit Before Tax amount?
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
$1,010,000
New Case
730,000
280,000
20,000
$30,000
260,000
10,000
Scenario Analysis
• What changed? By how much?
• Was the outcome different than you had expected it to be?
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year New Case
$10,000
____0
10,000
0
10,000
____0
$10,000
1%
0%
3.7%
_05
100%
_0%
50%
$ Change % Change
1% Increase in Selling Price = 50% Increase in Net Profit Before Tax !
$1,010,000
730,000
280,000
260,000
20,000
10,000
$30,000
Increasing Product Mix and Penetration
Scenario Analysis
• Start with base year information.
• If we increase sales volume by 1%, what effect do we EXPECT this to have on our profit?
• What effect does this change ACTUALLY have on our net profit before tax?
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
Scenario Analysis
• If we increase Sales Volume by 1%, how do you think this will affect our Net Profit Before Tax amount? Presume that the rate of COGS remains the same percentage of sales and that 50% of Operating Expenses are fixed and does not change with sales volume.
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
$1,010,000
737,300
272,700
261,300
11,400
10,000
$21,400
New Case
Scenario Analysis Operating Expense : $260,000 (50 % Fixed Cost)
Prior Period: Fixed -- $130,000 Variable -- $130,000
This Period: Fixed -- $130,000 Variable -- $130,000 x 1.01 = $131,300
Total fixed & variable = $130,000 +131,300 = $261,300
Scenario Analysis
• What changed? By how much?
• Was the outcome different than you had expected it to be?
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
$1,010,000
737,300
272,700
261,300
11,400
10,000
$21,400
New Case
$10,000
7,300
2,700
1,300
1,400
___0
$1,400
1%
1%
1%
0.5%
14%
0%
7%
$ Change % Change
Scenario Analysis
• Wow! A 1% increase in our sales volume results in a 7% increase in Net Profit!
• What are some of the ways in which sales volume can be increased?
Improving Purchasing
Scenario Analysis
• Start with base year information.
• If we reduce Cost of Goods Sold by 2%, what effect do we EXPECT this to have on our profit before tax?
• What effect does this change ACTUALLY have on our net profit before tax?
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
Scenario Analysis
• If we improve in Purchasing and are able to reduce our Cost of Goods Sold by 2%, how do you think this will affect our Net Profit Before Tax amount?
Scenario Analysis
Net Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year
$1,000,000
New Case
715,400
284,600
24,600
$34,600
260,000
10,000
Scenario Analysis
• What changed? By how much?
• Was the outcome different than you had expected it to be?
Scenario Analysis
Net SalesCost of Goods Sold
Gross Profit
Operating Expenses
Operating Profit
Other Income/Expense
Net Profit Before Tax
$1,000,000
730,000
270,000
260,000
10,000
10,000
$20,000
Base Year New Case
$0
(14,600)
14,600
_____0
14,600
___0
$14,600
1%
(2%)
5.4%
0%
146%
0%
73%
$ Change % Change
$1,000,000
715,400
284,600
260,000
24,600
10,000
$34,600
A 2% reduction in COGS Results In a 73% increase in Net Profit Before Tax !
Scenario Analysis
• Wow! A 2% reduction in our COGS results in a 73% increase in Net Profit Before Tax!
• How can we reduce COGS?
