Question

There are two companies, A and B, which have facilities to produce the same products. A's operating income is 15% and B's operating income is 25%. In general, company B can be considered a profitable company with higher internal efficiency. But if actual B is not better at internal competencies, explain how the above operating profit could have been achieved. (Hint: B may have been using the equipment for a longer period of time.)

Answer 1

A and B are having the same facilities to produce the same products and operating income of B is 15% and operating income of A is 25%Company B is not better at internal efficiency but still B has achieved higher rate of operating income in comparison to B. It is quite possible that B may have been using equipment for a longer period of time. If the equipment has been used for a longer period of time then depreciation expense of equipment that is a charge against profit may be lower and hence it will increase operating income.

It may also possible that Company B is providing less amount of salary and perks to their employees and they have provided huge employee stock option which is to be granted at a future date. Due to future benefits in company, employee may be working at lower salary with full amount of efficiency. Lower amount of perks and remunertaion may decrese total revenue expenditure of company and hence it will have positivve effect on operating income.

It may also possible that Company B has more amount of working capital than Company A and Company B ordered bulk quantity of raw materials from suppliers and suppliers has provided special discount or lower rate per unit of raw material to Company B due to bulk order. Low rate of raw material will decrease the manufacturing cost of product of Company B and finally overall cost of production will be reduced. Decrease in cost of production will have positive effect on operating income and hence operating income will be increased.