Question

Gopher Gulch Corp. is a little two-store retailer operating in a local market. Its problem is that one store in the company is losing money while the other one is making money, based on company financial reports, causing the company as a whole to lose money. The most recent income statement for Gopher Gulch Corp. is given below:

                                      Store 1                       Store 2                           Total
Sales                                        $976,000                  $1,145,000                     $2,121,000

Variable costs                         (593,000)                     (685,000)                    (1,278,000)
Contribution margin                383,000                     460,000                          843,000

Traceable fixed costs            (470,000)                     (269,000)                        (739,000)

Store segment margin             ( 87,000)                    191,000                           104,000
Common fixed costs               (116,000)                       (85,000)                         (201,000)

Net operating income (loss)   $(203,000)                   $ 106,000                      $ (97,000)

Because of its poor showing, Gopher Gulch Corp. officials are considering closing Store 1. However, management and the workers at Store 1 say, “Not so fast!” A study by a consultant hired by Gopher Gulch Corp. officials show that if Store 1 is closed, 39 percent of its traceable fixed costs will continue unchanged. The study also shows that closing Store 1 would result in a 28 percent decrease in sales in Store 2. The company allocates common fixed costs, such as your corporate officials’ salaries and advertising costs, to the stores on the basis of square footage of the stores. Management and workers at Store 1 claim that Store 1 is being unfairly targeted for closure.

Your uncle, the CEO of Gopher Gulch Corp., knows that you are a student in the prestigious Delta State University Integrated Master of Business Administration (IMBA) Program, and so has turned to you for advice on what to do.

Required

• Compute Gopher Gulch Corp’s total net operating income (loss) if Store 1 is closed. (Hint: The answer will entail determining the lost contribution margins for Store 1 and Store 2 offset by the amount of fixed costs shed by closing Store 1. Pay close attention to the percentages listed above.)

• Compare the total net income (loss) when the two stores are open with the total net operating income (loss) when only Store 2 is open. Is the total net operating income greater (total net operating loss smaller) when two stores are open or when only Store 2 is open?

• Based on your calculations above, what should you tell your uncle regarding Store 1? In other words, should Store 1 be closed or do store management and workers have a basis for their claims and both stores should remain open?

• Given the profit or loss overall for the company, what is your recommendation to your uncle regarding the capital invested in Gopher Gulch Corp.? In other words, “eyeball” the value of the assets of the company versus the profit (loss) generated by those assets. Should the company continue to operate one (or both) stores, or should the company get what money it can for the assets and invest that money elsewhere (such as in another business, bonds, stocks, T-bills, etc.)?

Ok, you are this “hotshot” turn-around specialist who will soon have a Delta State University IMBA degree. For you to turn around your uncle’s company as a retail operation, you must get a handle on the company’s costs -- variable, traceable fixed, and common fixed.

Required

• Variable costs for each store individually is what percentage of that store’s sales revenue?

• Total fixed costs for each store individually is what percentage of total sales revenue for that store?

• Do fixed costs for each store individually appear to be reasonable, unreasonable, or cannot be determined. Explain your answer.

• Is net operating income as a percentage of sales revenue for Store 2 “reasonable?” Explain your answer.

• Traceable fixed costs for each store individually is what percentage of the individual store’s sales revenue?

• What percentage of total company sales revenue does each store provide?

• What percentage total common fixed costs for Gopher Gulch Corp. is charged individually to each of the stores?

• Does the allocation of common fixed costs to each store appear to be equitable in light of the sales revenue generated individually by each store?

• On what basis do you believe that common costs should be allocated in Gopher Gulch Corp.? (Be specific.)

• Based on your review of various costs for each of the stores individually, why do you think Store 1 has a net operating loss?

• As a turnaround specialist, what steps do you recommend to turn Gopher Gulch Corp. around into a profitable retail company? (Be specific.)

• Do the costs relative to sales revenue appear to your “practiced professional eye” to be excessive, low, or within a “reasonable range”?

• Analyze the distribution of the costs between the two stores. Do you see anything that seems awry?

• What effect does what you identified in the question immediately before this one have on determination of store operating costs?

• In answering the questions above, you have examined sales revenue, various categories of cost, costs relative to sales revenue, the distribution of costs between stores, and the contribution margins of each store. After doing all of these analyses, what is your advice to your uncle on how best to make Gopher Gulch Corp. profitable, or is that not even possible?

Answer 1

Scenerio : If Store 1 is closed
Sales	824400
Variable costs	493200
Contribution margin	331200
Traceable fixed costs	452300
Store segment margin	-121100
Common fixed costs	201000
Net operating income (loss)	-322100

should Store 1 be closed or do store management and workers have a basis for their claims and both stores should remain open? Both stores should remain open.

Total Contribution Margin when both stores are open 843,000 (40%)

Total Contribution Margin when single store is open 331,200 (40%)

Loss Contribution 511,800

Reduction in Fixed costs 286700

Net Loss Contribution 225,100

Net operating loss when both stores are open (97,000)

Net operating loss when single store open (322,100)

Variable costs to sales revenue Store 1 - 61% Store - 60%

Fixed costs to sales revenue Store 1 - 60% Store - 31%

Fixed costs are appeared to be unreasonble for each store. 61% for store 1 means it can not make any profit unless it improves its sales figures drastically or reduce its fixed costs substantially. Square footage is more than that of store 1 and sales are llesser in comparison means there is scope for reduction in the space resulting in reduction of fixed costs or to increase sales.

31% fixed costs for Store 2 is also high as it left small portion for profit.

Net operating income as a percentage of store 2 is 9% and is not reasonable. Any decrease in sales or increase in variable cost will immediately result in loss.

Traceable fixed costs to revenue - store 1 - 48% store - 2 - 23%

Contribution of each store to revenue - store 1 - 46% store - 2 - 54%

Contribution of each store to common fixed costs - store 1 - 58% store - 2 - 42%

Allocation of these common fixed costs is not fair and should be allocated based on revenue. These may be related to procurement, management expenses and should be distributed based on revenue.

Scenerio : If common fixed costs are allocated based on revenue
	Store 1	store 2	Total
Sales	976000	1145000	2121000
Variable costs	593000	685000	1278000
Contribution margin	383000	460000	843000
Traceable fixed costs	470000	269000	739000
Store segment margin	-87000	191000	104000
Common fixed costs	92460	108540	201000
Net operating income (loss)	-179460	82460	-97000

From above, even after allocating common fixed costs on equitable basis, store 1 still makes loss and profitability of store 2 is reduced.

Store 1 has net operating loss because it has high volume of fixed costs and its turnover is not comunserate with its size. Following options can be considered:

1, Increasing the sales revenue

2. Leasing out the some portion of the store

3. Reducing the store space which can result into reduction in rents.

4. Looking in to reducing unnecessary tied in costs.

To make turnaround of the company, in addition to the suggested steps above, it should look into following additional options:

1. Increasing Selling Price

2. Negotiating with vendors for price reduction

3. Weeding out low margin or negative margin products.

With all these measures, there is a possibility for turnaround.

Yes, the costs related to sales are excessive and cost management is need of the hour.