The six-months cash forecast for Ken Electricals Ltd., which manufactures household electrical goods shows that, unless drastic action is taken, the company will be in a serious liquidity problem. It is decided that outlay on all types of expenditure must be reduced without significantly affecting the forecast sales. Select six headings of expenditure where you consider economies could be made, and describe how you would achieve savings in these areas.

Advanced Financial Management Block Revision Mock Exams

Where expenditure must be reduced without detriment to forecast sales some possibilities in a manufacturing business are:

(i) Purchase of materials
It is possible that stock holdings could be reduced, thus saving purchases into immediate future. If stocks are indented on the basis of re-order or in fixed re-order quantities, do a quick review of those levels and quantities for the major value items having regard to the current trend of demand.

It may be advantageous to impose an arbitrary limit on the value of purchase orders to be placed each week or month. This has the advantage that the buyer will not automatically purchase everything that is requisitioned but will discuss priorities with the other managers, that the production managers will have to review the necessity for ordering supplies in advance; and that the sales manager may have to be more selective in choosing to take those orders which will yield the best margin of profit.

(ii) Operating costs
Overtime work might be discontinued except urgent customers‟ demands. Quality control standards might be reviewed to ensure that they were not more strict than necessary to satisfy customer requirements. A more rigorous review of the causes of waste and scrap might be instituted.

(iii) Staff costs (work, selling and administration)
An embergo might be placed on recruitment, including replacement, subject to review the managing director. The use of temporary staff might be forbidden if necessary there could be an arbitrary cut in staff numbers, having regard however to any redundancy payments involved.

(iv) Capital expenditure
„Luxury‟ items like office reorganization could be cancelled or postponed. Replacement of plant and motor vehicles might be delayed. Consideration could be given to leasing, contract rental or hire purchase as alternatives to outright purchase.

(v) Discretionary costs
The number of publications purchased might be reduced; subscriptions and donations cancelled, and the scale of advertising cut down (though this may not be possible if there are annual contracts).

(vi) Other overheads
Apart from renewed exhortations to switch off lights, make telephone calls after 1.00 p.m, use telex instead of telephone, re-use envelopes and so on saving might be achieved slight reductions in office temperature, attempting to eliminate private use of telephone, and more careful control issue of stationery stock. In the longer term all office systems and all management information reports ought to be reviewed.

What action should be taken will depend very much on whether this is a short-term or long-term problem. If it is a long-term problem then the business is probably inefficient
and a though review will be needed. If it is short-term problem then case must be taken that immediate economies do not result in longer-term losses.

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