RMC is a privately owned business. Products manufactured by RMC had been doing v
ID: 2467857 • Letter: R
Question
RMC is a privately owned business. Products manufactured by RMC had been doing very well until the year 2011. The last two years have seen a steady decline in sales and profit. If this declining trend continues, the company might come under financial distress. Income statements for the last two years are given below.
Year 1 Percent Year 2 Percent
Sales $ 4,000,000 100 $ 3,600,000 100
Less Variable Expenses $ 3,000,000 75 $ 2,700,000 75
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Total Contribution Margin $ 1,000,000 25 $ 900,000 25
Less Fixed Expenses $ 500,000 $ 500,000
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Net Income before taxes $ 500,000 $ 400,000
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Mr. Creighton, the owner of the company is baffled that only a ten percent decline in sales has resulted in a twenty percent decline in profits. He asks you to explain to him how in spite of maintaining efficiency in operations by keeping variable expenses and contribution margin at the same percentage level, he has experienced a greater percentage decline in profits.
Explanation / Answer
Besides of maintaing the same % level of variable exp and margin ratio, RMC has experienced a lot decline in profits. This is due to the fact that, with the fall in sales the fixed cost remains at the same level. It was $500000 at the previous level of sales of $40Lacs and remained same when the sales were $36lacs. So with the non movement of fixed exp, profits of the company declined with more %. If we calculate % of fixed exp to sales, it was 12.5% when the sales were $40lacs and increases to 13.88% when the sales declined to $36Lacs. Due to this profits of the company declined with more %
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