Question

You have been recruited by a former classmate, Susanna Wu, to join the finance team of a company that she founded recently. The company produces a unique product line of hypoallergenic cosmetics and relies for its success on an aggressive marketing program. The company is in a start-up phase and therefore has no significant history of expenses and revenues upon which to rely for budgeting and planning purposes. Given the restriction on available funds (most of the available capital has been used for new-product development and to recruit a management team), the control of costs, including marketing costs, is thought by the management team to be essential for the short-term viability of the company. You have held a number of intensive discussions with Susanna and John Thompson, director of marketing for the firm. They have asked you to prepare an estimated budget for marketing expenses for a month of operations. You are provided with the following data, which represent average actual monthly costs over the past three months: CostAmountSales commissions$125,000Sales staff salaries42,500Telephone and mailing40,500Rental—office building22,500Gas (utilities)12,500Delivery charges71,500Depreciation—office furniture9,500Marketing consultants25,500 Your discussions with John and Susanna indicate the following assumptions and anticipated changes regarding monthly marketing expenses for the coming year: Sales volume, because of aggressive marketing, should increase by 16%.To meet competitive pressures, sales prices are expected to decrease by 8%.Sales commissions are based on a percentage of sales revenue.Sales staff salaries, because of a new hire, will increase by 16%, regardless of sales volume.Because of recent industrywide factors, rates for telephone and mailing costs, as well as delivery charges, are expected to increase by 6%. However, both of these categories of costs are variable with sales volume.Rent on the office building is based on a 2-year lease, with 21 months remaining on the original lease.Gas utility costs are largely independent of changes in sales volume. However, because of industrywide disruptions in supply, these costs are expected to increase by 16%, regardless of changes in sales volume.Depreciation on the office furniture used by members of the sales staff should increase because of new equipment that will be acquired. The planned cost for this equipment is $14,400, which will be depreciated using the straight-line (SL) method, with no salvage value, over a 4-year useful life.Because of competitive pressure, the company plans to increase the cost of marketing consultants by $7,500 per month.

Required:

1. Based on the preceding information, what is the percentage change, by line item and in total, for items in your budget?

2. The management team is worried about the short-term financial position of the new company. Given the strain on available cash, the president has expressed a desire to keep marketing expenses over the next few months to a maximum of $363,000. Discussions with the marketing department indicate that telephone and mailing costs are the only category, in the short run, that can reasonably bear the planned-for reduction in marketing costs. The budget you have prepared includes an assumed 6% increase in telephone and mailing costs. What must this percentage change (positive or negative) be in order to achieve targeted monthly marketing costs? (Hint: The Goal Seek function in Excel can be used to calculate the percentage changes, which can be found under Data, then What-If Analysis.)

Answer 1

Cost	Existing	Percentage change	Revised Amount
Sales commissions	125,000	6.72%	133,400
Sales staff salaries	42,500	16.00%	49,300
Telephone and mailing	40,000	22.96%	49,184
Rental—office building	22,500	22.96%	27,666
Gas (utilities)	12,500	0.00%	12,500
Delivery charges	71,500	16.00%	82,940
Depreciation—office furniture
Existing Furniture	9,500	0.00%	9,500
New Furniture			292
Marketing consultants	25,500	29.41%	33,000
Total Budgeted Monthly Cost			397,782

Formulas:-

To achieve the monthly targeted cost of $363,000, the rate of "telephone and mailing" costs cannot increase at all(as is the case in the proposed budget); in fact, the results of the "goal seek" analysis indicate that such ratesmust decrease by approximately 64%, as shown below:

Cost	Existing	Percentage change	Revised Amount
Sales commissions	125,000	6.72%	133,400
Sales staff salaries	42,500	16.00%	49,300
Telephone and mailing	40,000	-63.99%	14,402
Rental—office building	22,500	22.96%	27,666
Gas (utilities)	12,500	0.00%	12,500
Delivery charges	71,500	16.00%	82,940
Depreciation—office furniture
Existing Furniture	9,500	0.00%	9,500
New Furniture			292
Marketing consultants	25,500	29.41%	33,000
Total Budgeted Monthly Cost			363,000

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