Importance of Costs in the Pricing Strategy of an Organization - Coursework Example

Name Course Instructor Date Section 1 Importance of Costs in the Pricing Strategy of an Organization Cost can be defined as the sum total of expenses incurred, measured in monetary terms used in the production process. There are different types of costs. The costs are dual and include expired costs and unexpired costs, manufacturing and manufacturing costs and as well fixed and variables. The costs are either direct or indirect to production. Firms today face altered conditions of competition that are pushing them to compete on the basis of factors other than price and cost competitiveness. 1 Price affects other marketing mix elements and is related to product positioning. It is influenced by factors both internal and external. Internally, pricing strategy is affected by organizational system, costs, cost of strategy implementation, and economies of scale and experience effects, amongst others. Management accounting tools require revenue and cost information to help construct decisions. In short-run pricing decisions marginal costs are vital since the company should be willing to set the prices at any amount in excess of the marginal cost 2 which comprises all variable costs. These opportunities may occur in case of over-production, one-time buyer, and a customer outside normal sales channels. In long-run pricing decisions, all fixed costs are very relevant and managers need to know prices are sufficient to well cover the total cost of production and yield profits. Unprofitable products should be faced out though this may depend on the cost of related fixed assets and whether the product is a loss leader. Intermediate-run pricing depend on demand elasticity and marginal production cost. With an unknown demand function, prices can be based on production costs, as the company gathers more information with time. Costing systems Costing system is basically an accounting system which is established within an organization for purposes of monitoring the costs in the organization and providing the management with the necessary information concerning the organization’s operation and performance (Donald, et al., 2009).There are many costing systems in use; however, they differ on their application and the nature and needs of the organization in question. These include; process costing, job order costing, batch costing and activity based costing systems. We consider process costing. Organizations like oil refining, chemical processing, pharmaceutical firms and the like are best suit to use process costing since they produce large quantities of identical products. Process costing system is a kind of costing system that obtains the product cost through fixing cost to large quantities of identical units. Since these products are produced in a similar way, the unit cost of the product will be determined based on average computation. That is, cost per unit = cost of mass production/total number of units produced. The unit cost of production is vital in the decision making process as it helps in pricing decision, inventory calculations and determination of the product profitability. Having determined the cost per unit, the management adds its profit margin to establish the selling price per unit of the product. Consider an oil refinery firm that produces thousands of tones of petroleum products, the firm will factor in all the direct costs and indirect costs incurred in the process of producing the products. The direct costs will include all the costs incurred for and can conveniently be identified to the finished product. Indirect costs include those costs that are incurred for and cannot be conveniently identified with the finished product. They are general and are incurred for the benefit of a number of cost units or cost centers. Improvements to the costing and pricing systems To improve a failing costing and pricing system, develop performance measures and metrics; adequately address information technology management costs (Gunasekaran, A. et al, 2005). A company may also invest in knowledge capital and management where employees are trained on virtual integration, purchasing and logistics, organized strategic formulation and streamlined operational controls to assist in implementation. Section 2 Use forecasting techniques in making cost and revenue decisions Forecasting is a very important risk management business function. Forecasting is a key activity of budgeting for costs and expenses and the expected sales, thus becomes equally important in pricing strategy. Forecasting techniques are divided into two major categories: quantitative (utilizes historical data) and qualitative (uses judgment and experience) techniques. Quantitative techniques include simple regression, multiple regressions, moving averages and time trends. Qualitative techniques entail the Dephni method, nominal group technique, scenario projection and the jury of executive opinion. Organizations either adopt the top-down or bottom-up route. Simple regression entails having the data of sales relating to both time and number of households. Sales are a function of both time and the number households in multiple regressions. In time series sales are plotted as a function of time while in moving average the sales units are plotted with two year moving averages. According to Shim and Siegel, 2009, sales forecasts are especially crucial aspects of many financial management activities, including budgets, profit planning, capital expenditure analysis, and acquisition and merger analysis. In order to schedule the full production process, forecasting is important. Also required include prices, market share, trends and new product developments. Revenue forecast helps a firm to plan for all costs, those directly and indirectly associated with sales. Although scholars rate it difficult due to unpredictable external factors, revenue forecast largely affects commercial decisions, profitability, survival and growth. Optimistic forecasts may lead to higher costs of obsolescence and inventory holding (Watson 1987) causing lower returns on capital investments whereas pessimistic forecast may lead to reputation damage and stock-out costs. Sources of funds for organizations Sources of funds can be broadly divided into two: long-term, medium-term and short-term. Projects are either medium-term or long-term and therefore require long-term source. They are long-term capital needs and may be for purposes such as financing growth and expansion, fixed assets and buffing the part of fixed working capital. A company may use a number of sources. Long term sources include shares which may be issued to the public. A share is a part of the company. There are two types of shares: equity and preference. The company may also issue debentures to the public thus borrow long-term finance from the public- debenture holders. By using retained earnings, the company distributes a percentage of profits among shareholders. One can also acquire loans from commercial banks who may lend on long-term basis. This is in addition to loans from financial or development institutions established by the government as an incentive for business. The company can explore leasing or mortgaging options. Whichever the source sought, the company should do a situational analysis of the economic times, feasibility of the project and as well weigh the merit and demerits of each source. Section 3 Budgetary process of an organization Budget formulation entails systematically following four dimensions. These are setting appropriate fiscal targets and equally compatible level of expenditures, developing expenditure policies along which the resources are allocated, allocate the resources and finally formulating control efforts and performance indicators. Identifying the appropriate targets is the main goal for which a micro-economic framework is developed. Fiscal targets should include current position, sustainability and vulnerability. These are based on historical performance, overall budget objectives and external factors. In budgeting, targets to be considered include: I was appointed in my organization’s (Point One Ltd) budget committee as a representative from the marketing department. Point One Ltd deals with motor vehicle repairs targeting the upper market. First, we determined our principle factor- sales, a derivative of different departmental budgets. Applying appropriate techniques we analyzed the sales budget, production budget, purchasing budget, labor budget, cash budget, administration, capital expenditures, research and development. The analysis assisted us develop the master budget with the key performance indicators being increased sales, low cost of production and improved efficiency to depicted by on-time delivery of services. Comparison of actual expenditure and income Actual expenditure and income to the master budget will usually differ from the budgeted expenditure and the budgeted income of an organization. This will mainly be as a result of poor forecasting during the budgetary process or the happening of unforeseen events. The deviation of the actual from the set standards can be two way. The budgeted expenditure may be lower than the actual expenditure or vice versa. This effect is transmitted to the income realized by the organization. If the actual expenditure is lower than the budgeted expenditure, the net income during that period will be higher and the reverse is true. Budgetary monitoring processes This is a financial operating procedure by which management ensures that the proposed action is achieved in monetary terms. The monitoring processes involve identifying the current position, comparing it with the expected position in the budget in order to plan on intervention actions required if any and finally taking action appropriately on the variance, which may be favorable or adverse (Frederick, David 2011). This is a continuous cyclic process that largely depends on information management and which requires that all employees get involved. Section 4 4. Recommend cost reduction and management processes for an organization: In any organization, the main aim when it in cost reduction is the use of ways that works with their company’s culture rather than against it. However, my take on this is applying strategies that will ensure sustainable cost reduction. This can only be achieved when the implementation of this strategy involves all the employees for it ensures their security. Any company looking for a cost reduction strategy, need to be assured of the positive emotional commitment of their employees to support the decision and commit to behavior change that reduces cost (Suzanne 2005). It is fact that a committed workforce can reduce cost more and sustain the reductions longer that a workforce that is not. This involves paying close attention to a set of principles through the approach called motivating cost discipline (MCD) which ensures fast and sustainable cost reduction by using ways that involve and motivate employees To ensure that the MCD is implemented effectively, then it need to be a fair process based on shared values, it must establish leadership cohesion and commitment, create the emotional as well as the rational business case, enlist frontline motivators, involve the organization in considering costs from four angles and finally implement organizational solutions that create lasting behavior change (Suzanne 2005).. It is important to recognize that, costs are caused by too many layers of many hand-offs. An organization therefore needs to work on areas which capture appropriate savings as well as achieve employees buy in. Activity based costing assigns costs on those activities that are real cause of the overhead and then considers giving cost to the products that demand the activity. It recognizes that special engineering, machine setups, and other set of activities causing cost lead the organizations to consuming resources (Shields et al 1996). Using the Activity Based Costing (ABC), the organization calculates the cost of the resources used in every activity and then assigns activities products used in the activities. This is a widely used procedure for it improves the accuracy of production cost information. Direct labor hours in most cases do not accurately represent the percentage of indirect sources consumed by a specific cost object in a given time. This causes product cost distort which can only be curbed by viewing the manufacturing system as being composed of activities and this is only evident in an ABC. The good thing about this model is that is supports managerial decision making by generating the rightful data necessary to support the theory of constraints (Spoede et al 1994) Section 5 5. Finance Appraisal techniques in making strategic decisions Development projects incur a series of costs which have beneficial factors to the community or countries. These costs and benefits can be social, environmental or economical (McLaney 2003). They mostly occur in three phases including selection, design and implementation. Any proposal is considered viable if it is economical, technically and financially viable. It should incur less cost to the problem solved and is expected to produce net economic or social benefits. In every project I would conduct an analysis of economic soundness of the entire project its qualification and the valuation of costs and benefits to ensure financial viability. Cost benefit analysis will be to determine the attractiveness of a proposed investment in terms of the welfare of the society and the shareholders. By using this analysis one is able to explore the choices between alternative options and also give ideas of how worth the project is (McLaney 2003). Investment decisions have financial implications and therefore the key strategy is budgeting process within the strategic planning process. I would use this so as not to get into a dead arrival caused by not linking budget with the strategic planning. After gathering all the relevant financial information, the financial information will result to a nice financial planning which will improve the forecasting which will lead to volumes for the planning period (McLaney 2003).. Financial information will help in estimating items like financing expenses and income tax expenses. Moreover, the financial information will result to a nice financial planning which will improve the forecasting which will lead When coming up with these decisions using a post audit appraisal can be effected effectively for one is having the hand on information of the financial status of the organization and therefore one has the accurate information to indulge in investments with that hand on information (Hair et al 2003). In any investment expenditure plays a crucial role in shaping their long term operating capability and their ability to withstand the ever changing environment and the economic growth of the organization and this can be effectively adhered to when post audit appraisal is used. Finally, it will ensure that the whole investment’s success of a capital expenditure project is well measured and adequately measured and that it is put in its rightful place in the due time and the expenses incurred are recovered from the investment in the due time and that the impact of the investments is felt in the planned time (Hair et al 2003). Section 6 6. Interpreting financial statements for planning and decision making: Financial statements give very precise information however they only show absolute figures for a particular period and at the end of the same period. So as to make acute and well informed decisions, the statement needs to be analyzed so as to get sufficient information. The viability of financial statements describes the assets, liabilities and capital of the said business in a given time. When analyzing this information calculating ratios; when doing these comparisons are made between the previous accounting periods, other companies in the same investments, government statistics just to mention but a few (Anthony et al 1994). These ratios can be classified into various groups in accordance with the information they convey ranging from profitability ratios, liquidity ratios, efficiency ratios, capital structure ratios and security/investors ratios. Just looking at figure and adding them up or comparing them provides additional tools that support decision making and these is the technique of ratio analysis. But since there is the use of ratios and it involves the use of comparisons, it is important to note that no company that is exactly the same with the other but the use of this information is very vital in decision making (Horngren et al 1997). The financial statements tell well the profit and the loss as well as the trading events that affected business in that given period. It also goes ahead and show how any net increase in business’s wealth over the given period of time was deployed. With this information, one can be able to have a tangible evidence of the financial strength and weakness of that given company and making decision in regard to the company, one has to collectively refer to this and in so doing the decision can be relied on for it is accurate. When all the information has been analyzed, then the usefulness of it and significance is when its absence has a negative influence on the end user decision (Horngren et al 1997).. This information is labeled important if it gives the end user a guarantee of credible, complete and description of the corporate transaction and economic events. The punctuality of the information is linked to its usability regarding the decision making process and therefore if it is delivered too late can be out of sate in regard to decision making. In connection to the ratio applied, the main aim of all of them is to assess the organizations ability to meet the total debt obligations. The desired ratio will be dependent on the level of income, volatility of income and the production risk (Horngren et al 1997). Reflective Learning Statement Throughout my learning, I have gained accounting and managerial knowledge that will help me through decision making in the organization. Having the accounting knowledge is only important when one is well equipped on how to use this information of which I have gained through the learning process. I also have precise information on how to use the financial information to make investment decisions to the advantage of the entire organization. I have gained the human potential which gives me the ability to manage business finances successfully to the competitive advantage of the company am involved in. Work Cited; Demsetz, H. (1968). “Why Regulate Utilities?” Journal of Law and Economics, 11: 55-65. Gretzel, U, Yuan, Fesenmaier Y, D. 2000. Preparing for the new economi advertising strategies and change in destination marketing. Journal of Travel Research, 39(2), 146 156. Horngren, Charles T., George Foster, and Srikant M. Datar, 1997. Cost Accounting: A Managerial Emphasis,p. 45-89 Lianabel, Oliver (2004). Strategic Cost Systems: How to unleash the Power of Cost Information, New Jersey: John Wiley & Sons, Inc.pp1-220 Miller H, Orr D 2001. ‘Model of the demand for money by firms’: Q. J. Econ.80( 3): 413-435. Marginson, David. & Ogden, Stuart. 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