Question

The management of Hess, Inc., is developing a flexible budget for the upcoming year. It was not pleased with the small amount of net income the budget showed at all sales levels and is contemplating using a less expensive material. This action reduces direct material cost by $1 per unit. What would be the effects on financial statements and a flexible budget if management takes this approach? Are there other factors that need to be considered?

Answer 1

Flexible budget-

Flexible budget means a budget which may be changed in accordance with change in plan or strategy.

In the given case the management is thinking to use low quality of material in production in order to increase its profitability. This action has root cause to increase in net income.

Increase in net income-

• It's is as subject matter of nature of business, it's location, it's competitive position in market and other factors are also necessary to focus on net income.
• The businesses must asses it's current position in order to analyse the profit of the business. They will need to closely watch the product process and it's market behaviour in order to take decision like use of inferior quality of material in production process.
• The businesses must relook at its value chain which is creating value in the business and producing net income.
• A highest level of strategic decisions and costing decision must be taken in order to ensure the maximisation of business net income.
• In term of strategic management the current market situation must be analysed to give the effect of giving the customer with inferior quality of product
• There must be cost analysis which is required to be done before using inferior material for production, Bulk order may be raised in order to have quantity discounts, labor efficiency may be checked with the highest level of standards used peers businesses.
• The businesses must analyse all the potential effects of lowering the product quality such as reduce in demand from customers and fame and goodwill may also be reduced.
• This will lead the business into much more problems than problem of low net income at current.

Overall the management should analyse all the possible effects of change in quality of product before taking this decision. These decisions should not be hypothetical but should be based on some rationales.

Please comment for additional explanation or suggestions

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