Question

In: Accounting

Silkworm Inc is a manufacturer of construction equipment, machinery and engines. It also sells financial services....

Silkworm Inc is a manufacturer of construction equipment, machinery and engines. It also sells financial services. You anticipate a substantial increase in its machinery sales. You have the following data.

US $'000 2018 2019
Net sales 39,867 57,392
COGS 30,367 43,578
SG&A 4,248 5,203


and thus in percentage terms:

% of sales 2018 2019
Net sales 100 100
COGS 76.2 75.9
SG&A 10.7 9.1


a) Estimate the fixed and variable components of COGS and SG&A in 2019. What would be your estimate of operating profits for 2020 if predicted net sales for 2020 were US$ 100,000,000? Briefly comment on whether your analysis makes sense. What are the advantages and disadvantages of this approach?

Solutions

Expert Solution

  • Like the answer and comment for any query.
  • First we will find variable COGS as % of Sales by using below formula:
    =Change in COGS / Change in Sales
    = ($43,578-$30,367) / ($57,392-$39,867)
    =$13,211 / $17,525
    = 75.38%
  • Variable COGS
    = 75.38% of Sales
    =75.38% * $57,392
    =$43,262
  • Fixed COGS
    = Total COGS - Variable COGS
    = $43,578 - $43,264
    = $314
  • Now, By following same procedure, we will find variable SG&A as % of Sales by using below formula:
    =Change in SG&A / Change in Sales
    = ($5,203-$4,248) / ($57,392-$39,867)
    =$955 / $17,525
    = 5.45%
  • Variable SG&A
    = 5.45% of Sales
    =5.45% * $57,392
    =$3,127.86
  • Fixed SG&A
    = Total SG&A - Variable SG&A
    = $5,203 - $3,127.86
    = $2,075.14
  • Estimated Income for 2020:
    = (Sales *(100%-Variable COGS as % of Sales -Variable SG&A as % of Sales))- Fixed COGS- Fixed SG&A
    =($100,000 * (100%-75.38%-5.45%))-$314-$2075.14
    =  $19,170-$314-$2075.14
    = $ 16,780
  • Note: All figures abover in $'000
  • The above income forecasted makes sense as cost of goods sold and SG&A Costs are in line with sales.In this analysisi,we have considered sales as a base to calculate income and to forecast expenses.
  • Main advantage to this approach is that Income can be easily determined using gross margin less fixed cost and other advantage can be that it is easy and simple to calculate method.
  • Main disadvantage can be that aligning every expense in terms of sales isn't practically feasible and change in prices within cost cannot always match with change in prices of sales which will be giving wrong results.
  • Please upvote the answer.

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