632598256894

Interestingly the numbers for quarters 3 and 4 are a bit different than our first analysis but are
exactly the same and are still quite close to what was arrived at using quarter 1 and 2 figures. 5 Given
this result, one could feel very confident that cost of sales for Company X is somewhere close to 34%
of net sales variable and approximately $54 million per quarter fixed. It should be understood that we
are estimating the future and we do not expect to be correct to a decimal point. Using this estimate, we
would have forecast cost of sales at $591.8 for the entire year if told that net sales would be $1,102.3
→ $1,102.3 × 34% + $216.0 ($54 × 4 quarters). Given that the actual total was $588.8, an error of
0.34% is more than acceptable [($590.8 - $588.8)/$588.8] for this type of analysis.
Unfortunately, using the same technique for the operating expenses (R&D and selling, general, and
administrative) does not work. Cost of sales is often called an “discretionary” cost, which means that it
is the result of an infrastructure built to support a long-term strategic plan. Operating expenses are
more often discretionary costs that are set by management‟s judgment based on the revenue estimate
for the coming fiscal year that would have to support them. They are more short-term in nature and
fixed for the period. From the cost data in Exhibit 12.1 it looks like Company X set the R&D spend at
about $50 million in the two lean quarters (quarters 1 and 4) and a bit above $52 million in the other
quarters. Selling, general, and administrative looks more like a constant $63 million a quarter (or a bit
under, to be exact).
Having now generated this cost structure information, is it possible to run forecasts for the scenarios
mentioned earlier?
Company X could increase output by 10% by utilizing excess facilities but would probably have to
be more aggressive in pricing to accomplish this or spend more on the marketing and sales promotion. 6
To facilitate these types of analyses, it is helpful to reformat the income statement in a manner that
now emphasizes the cost behavior of the firm rather than the functional nature of its costs. Exhibit
12.3 illustrates this by reformatting the fiscal year results for Company X, the first column showing
the dollar amounts and the second the percentages based on sales for variable costs. net sales less
variable cost of sales yields a number that is often called “contribution.” 7 On a percentage basis, it
reflects that for every dollar of incremental revenue, variable costs would increase by 34 cents,
resulting in a net contribution of 66 cents. The term contribution is literal since this 66 cents
contributes to a sum that must cover the fixed costs for the period as well as any profit that is needed
to satisfy investors.