Therefore, the firm will need to look at the impact that ending production may have on the sale of other goods. However unless there is a complimentary item then it would appear some changes may need to take place.
If there is a loss with the fixed costs of $1,000,000 it is will be expected that higher fixed costs will increase the loss.
Assessment with fixed costs at $3,000,000 per day
If the fixed costs are higher or increase the calculations will change and the average total cost per unit will change. The total and average variable costs will not change, so the same figures already calculated may be used. The average total cost is increased as shown in table 6.
Table 6; Average total cost with $3,000,000 fixed cost
Total variable costs (a)
4,400,000
Total fixed costs (b)
3,000,000
Total costs (c ) (a + b)
7,400,000
Number of units (d)
200,000
Average total cost (c/d)
37
The average total cost per unit is now 37; this is a significant increase and shows that the firm is loosing 12 per unit produced (37-25). This can be used to look at the new total loss incurred, which is shown in table 7.
Table 7; Loss for each scenario
Number of units sold (a)
200,000
Price per unit (b)
25
Total revenue (c ) (a x b)
5,000,000
Total costs
7,400,000
Profit/loss
-2,400,000
The loss has increased significantly. The decision whether or not to continue production remains the same as in the previous scenario, with the need to consider the overall impact it is having on the firm, either tying up resources and creating overall losses, or supporting the sale of complimentary items. If there are complimentary items, in this instance the profit would need to be higher to compensate for the losses compared with the previous scenario.
Reducing Employees
In both cases the way in which the firm may turn around...
With the knowledge of the total loss for each scenario and the average wages, the potential for reducing the total cost by reducing the number of workers may be assessed. The calculation showing the number of workers that would need to be lost is shown in table 8.
Table 8; Reduction in workers required for breakeven
$1,000,000 fixed costs
$3,000,000 fixed costs
Loss
400,000
2,400,000
Average wage per employee
80
80
Number of employees
5,000
30,000
The scenario with fixed overheads of $1 million would require the workforce to be reduced by only 5,000, which is a 10% reduction, and would require the remaining employees to increase their productivity to 4.44 units per day, which also an increase may be seen as potentially viable as it is only 11% increase. However, in the scenario where the overheads are $3 million, the workforce would need to be reduced by 30,000, which is equivalent to a 60% reduction in the workforce. In order to continue producing the same level of units per day productivity would have to increase to 10 units per day, an increase the 150%, and unlikely to be viable. Therefore, while it may be argued that if fixed costs are $1 million the organization has the potential to make the changes necessary in order to breakeven, it is unlikely this is possible if the fixed costs of $3 million. In a scenario of $3 million fixed costs it is likely that a recommendation will be to cease production immediately. In this scenario of $1 million overheads there is the potential for improvements to be made to breakeven.
References
Gillespie a, (2010), Business Economics, Oxford, Oxford University Press
Seal, Will; Garrison, Ray H; Noreen Eric W, (2011), Management Accounting, McGraw-Hill Higher Education
Thompson JL, (2007), Strategic Management; Awareness and Change, London, Thompson Business Press.
