Question

5. Total sales of ABC Corp. are $ 100 M and net income is $ 11,5M. The manager thinks eliminating the group marginal customers that constitutes the 10% of the total sales, will increase. Distributing the incomes and expenses of the Company between the marginal customers and credible customers based on income statement, indicate whether the company should eliminate marginal customers or not.

Percentage of sales total fixed variable

Cost of sales (%) 70 - 70 Overhead cost (%) 15 8 7

Collection exp.(%) 1 - 1

Other exp. (%) 2.5 2 0.5

Answer 1

The Net Income for all customers (Credible + Marginal customers) is $11.50 and Net Income % is 11.5%. However, without the marginal customers (of 10%), Net Income falls to $9.35 with Net Income % falling to 10.4%.

This is primarily because the marginal customers contributing to absorbing $2.15 of fixed costs earlier. With no revenue from marginal customers, this $2.15 results in decrease in net income. Hence the company should not eliminate the group of marginal customers.

Note:

1. A Marginal customer is one who purchases goods not at the list price or favourable price of the company but at a lesser rate (with a discount). The question is silent on volumes sold to these customers or the sale price per unit to these customers. These details will help in better analysis of this question as the contribution margin generally is lower for marginal customers.

2. The variable costs changes with respect to change in sales. Hence the contribution margin (Sales minus variable costs) will remain the same irrespective it is total or only credible customers.

3. Fixed costs remain constant irrespective of sales size. Hence a reduction in sales will not reduce the fixed costs.

Workings: