Case 14-1: Pet Groom & Clean (Pg&C)
After analyzing past customer preferences, in 2010 store 88 initiated a promotion to increase mid-week sales to even out demand - Case 14-1: Pet Groom & Clean (Pg&C) introduction. In the past approximately 80% of services were incurred on Friday, Saturday and Monday, compared to 20% incurred on Tuesday, Wednesday and Thursday. To even out the demand for services, the store initiated a program to decrease the service price to $18 on Tuesdays, Wednesdays, and Thursdays and increase the price to $30 on Fridays, Saturdays, and Mondays. Through careful scheduling of staff, budgeted labor time was also decreased from 2,500 hours to 2,250 hours per employee.
In addition to the budgeted operating statement and the actual operating statement for 2010, to increase the analysis a flexible budget was created. The flexible budget adjusts revenues and expenses to the actual output level achieved. Here increased sales units could be analyzed given the budgeted rates for variable costs and fixed expenses. The flexible budget enables an analysis of the variances related to selling price, sales volume, sales mix, variable cost per unit, and total fixed costs. The breakdown of total operating income variance is attached for your reference. Below is a detailed analysis of the findings. ANALYSIS
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In 2010 store 88 increased pet grooming services from the 10,000 budgeted to 10,500. This five percent increase is attributable to the promotion to increase mid-week sales. By lowering the service price for mid-week services and increasing the price for weekend services, the strategy was to even out demand and labor throughout the week. While service units increased by five percent, gross sales increased by eleven percent. The average unit price increased from $25 to $26. 40. The increase in the average unit price shows that demand remained high for the weekend services, given that more customers chose the $30 service over the $18 service.
By separating services into two categories, the store created a sales mix. ? 2010 Sales Mix X = $18 services Y = $30 servicesX+Y = 10,500 Services18Y + 30X = 277,200 X+Y = 10,500 – Multiply each service by 18 18X + 18Y = 189,000 – substitute 18Y with 277,200 – 30X 18X + 277,200 – 30X = 189,000 X = 7,350 – substitute 3,750 into 18X + 18Y = 189,000 equation and solve for Y Y = 3,150 In 2010, the store incurred 3,150 mid-week sales (30%) and 7,350 weekend sales (70%). This proves that the marketing strategy increased mid-week sales from 20% to 30%. This sales mix caused variances in the actual operating income and the budgeted operating income.
The flexible budget, flexible-budget variances and sales volume variances provide further analysis into the profitability of the operations. Use of the flexible budget shows the budgeted operating income given the actual sales. When you compare the flexible budget to the actual budget you are able to compare the total sales and cost incurred given the same units sold. The sales price variance, which is the actual sales less the flexible budgeted sales, was $14,700 favorable. This means that actual sales were higher than budgeted sales at that usage. This is attributable to the increase in service price from $25 to $26. 0. Price variance for material usage was $2,100 over the flexible budget projection. This could be attributed to overuse or waste of materials. As expected, the direct labor price variance was $3,375 lower than the flexible budget amount. This is attributed to the manager’s effective use of labor. Operating expenses were also higher than the flexible budget predicted by $3,675. In other expenses, the training expense was lower than the flexible budget projected. Training hours should have totaled 18 for the year (three employees and six hours of training each), but only 11 hours were incurred.
While this shows as a favorable variance on the operating income variance breakdown, a lack of training could decrease the quality of service provided at store 88. Advertising expenses were $1200 higher than the flexible budget. Due to the new program and pricing, the advertising price variance is attributed to the increase in marketing to inform customers about the program and change. PG&C recommends that advertising expenses are 1% of sales, but the manager of store 88 chose to increase advertising to a higher rate. Service development is charged to the store as a function of total sales.
Since total sales were higher than the flexible budget projected, this number is respectively higher. Accounting, insurance, taxes and management overhead are paid by the head office of PG&C and are allocated on a formula which combines store size, store sales, and the age of the store. In 2010 those costs were all higher than the amount budgeted. Accounting and insurance were $1,750 higher (15%), taxes were $1,000 higher (9%), while management overhead was $13,000 higher (25%). Since these costs are assigned by the PG&C home office, it is difficult for the store to project the costs.
Since labor usage decreased over the year, the employee benefit price variance is $675 favorable in comparison to the flexible budget. The total flexible-budget variance for 2010 is the difference between the flexible-budget operating income and the operating income actually earned during the period. For store 88, the total flexible-budget variance was $5,845 unfavorable. While the store experienced higher gross sales, the increase in materials and operating expenses in the variable expenses and the other expenses that were dependent on sales more than offset the increase in sales.
When you compare the flexible budget to the master budget, you are able to analyze the two budget columns on the basis that the sales volume was different than planned. The usage variance is the difference between the flexible budget sales and the master budget sales which was $12,500 favorable. This is due to the 500 increase in services. All of the variable expenses have an unfavorable sales volume variance due to the increase in sales units. For other expenses, where the flexible budget differs from the budget, the sales volume variance is unfavorable. This is due again to the increase in the sales units.
The sales volume variance measures the effect of changes in sales volume on revenue, expenses, contribution margin, or operating income of the period. Store 88 incurred a $6,250 favorable sales volume variance in 2010. This favorable number is attributed to the fact that sales services increased, but the selling price and variable cost per unit data from the budget were used. The fixed costs are assumed to be the same, which also lead to the favorable number. The total operating income variance is the difference between the actual net income and the budgeted income.
This is the number that the executives use to analyze net income increases over the budget. Store 88 incurred $405 more in actual net income than the budgeted amount. CONCLUSION Throughout the year of 2010, store 88 actively pursued a marketing strategy to increase mid-week services. That strategy successfully changed the sales mix to 30 percent mid-week and 70 percent weekend as compared to 20 percent and 80 percent in past years. While increasing mid-week sales, the pricing strategy also increased the unit sales cost to $26. 40.
Both of these combinations lead to higher gross sales for the store. That promotion and pricing strategy could be used by other store locations effectively even out services provided and better allocate labor. Those increases were offset by higher than expected variable expenses (excluding labor) and other expenses that are allocated by the home office of PG&C. The largest increases were seen in the accounting, insurance, taxes and management overhead allocations. Since those costs are allocated by a formula used by the home office, it is difficult for the store to adequately plan for those costs.
If the home office provided the stores with detailed information about those formulas, the stores would be adequately educated to make management decisions that are in line with minimizing those costs. Unfortunately, stores are evaluated solely on the basis of actual net income increases over budgeted amount. This snapshot does not encapsulate all of the information provided in this analysis. PG&C could initiate a thorough flexible-budget analysis of store operations to better understand the operating income variances.
This information would educate PG&C, as well as store managers, on the profitable and unprofitable variances that the stores experience. Additionally, PG&C could initiate a management bonus program for innovative and effective marketing programs. Throughout 2010 store 88 increased the number of services, increased unit service prices, and improved the number mid-week services. These improvements would be beneficial to share with other store locations that have the same type of sales patterns. By promoting innovation and sharing those profitable programs with other stores, both the stores and PG&C headquarters benefit.