50.1K

Verified Solution

Link Copied!

What should Rachel Miller Do?

How can Rachel improve the profits of the family business?

MILLER'S GIFTS

Rachel's mom, Mary, started the company seven years ago to earn extra income to help with Rachel's tuition. For the first two years, Mary ran the business out of the family's basement in Louisville, Kentucky. By year three, the business grew large enough that Mary moved it to a suitable location in the industrial park. A major competitive advantage was, and is, the UPS hub at the Louisville International Airport. Miller's Gifts sold gourmet gift baskets on-line in a simple business model: Mary purchased gourmet products from around the U.S., had them shipped to Louisville via UPS, packaged them in gift baskets, and delivered the baskets via UPS. Due to Mary's excellent gourmet taste, clever internet marketing, reasonable pricing, frugal operations, and attention to customer service, the business grew quickly. Revenues steadily increased each year, and generated increasing profits for the first four years, but profits have declined the last three years, as shown in

GAAP-BASED INCOME STATEMENTS

From her MBA studies, Rachel used her newly acquired accounting knowledge to prepare GAAP-based income statements for 2011 to 2017, as shown in Table 2 (Appendix). Then, Rachel used her new skills to prepare common-size income statements, as shown in Table 3 (Appendix).

---

CONTRIBUTION MARGIN INCOME STATEMENTS

Rachel wants to know how sales are contributing to profitability. To do so she needs to reconfigure the GAAP-based statements into contribution margin statements. She knows that GAAP-based statements are appropriate for investors and creditors. But, Rachel has learned that contribution margin statements can be more useful for internal decisions making. Contribution margin statements separate expenses into variable and fixed components, computes contribution margin by subtracting total variable costs from sales revenue, and then subtracts total fixed costs to arrive at net income. Rachel first used the GAAP-based income statements to identify the variable and fixed costs, as shown in Table 4 (Appendix). Rachel then prepared contribution margin income statements, as shown in Table 5 (Appendix), and a schedule of contribution margin percentages, as shown in Table 6 (Appendix).

====

BREAK-EVEN ANALYSIS

An advantage of the contribution margin approach is that we can quickly and easily estimate breakeven sales. Breakeven is simply the amount of sales required to generate a net income of zero; i.e.: to exactly cover total costs (both variable and fixed). Sales above breakeven will generate a profit and sales below breakeven will generate a loss. For example: for 2011, fixed costs were $5,000 and the contribution margin was 43.75% (see table 6). For every dollar sold, fifty-six cents of variable costs are incurred, resulting in a forty-four-cent contribution to fixed costs. Therefore, the $5,000 fixed costs divided by 43.75% results in breakeven sales of $11,428.57. Note that every dollar sold over breakeven will generate forty-four cents of profit and every dollar less than breakeven will generate forty-four cents of loss.

===

CONTRIBUTION MARGIN ANALYSIS FOR THE FIVE PRODUCTS

Rachel thinks the analysis so far is very useful, but it would be even more helpful to know how much profit each of the five products provides and whether there are differences across the five products that impacts the company's overall profitability.Luckily, Rachel and Mary tracked sales by product over the years. The Coffee Lover's gift basket was introduced in 2011. The Baked Goodness Basket was added in 2012, followed by the Chocolate Lover's Basket in 2014, the Wine & Cheese Lover's Basket in 2015, and the Ultimate Gourmet Basket in 2016. Table 10 (Appendix) reflects the total units sold and the sales price for each of the five gift baskets from 2011 through 2017. Tables 11 and 12 (Appendix) reflect the estimated total cost of goods sold and the estimated total selling and distribution costs, by product, for 2011 through 2017. Using this information, it is possible to prepare a contribution margin analyses for each product, by year. Tables 13, 14a, and 14b (Appendix) provide a contribution margin analysis per unit and in total for 2011 (Coffee Lover's Basket) and for 2012 (Coffee Lover's Basket and Baked Goodness Basket).

----

What should Rachel Miller Do?

How can Rachel improve the profits of the family business?

Answer & Explanation Solved by verified expert

See Answer