The Proposed Change to Level Production

The Proposed Change to Level Production

Having experienced one selling season at Scabberous Dave's, Capt. Bob was deeply impressed by the many problems that arose from the company's method of scheduling production. Overtime premiums reduced profits; seasonal expansion and contraction of the work force resulted in recruiting difficulties and high training and quality control costs (though the recruiting trips to Tortuga were enjoyable). Machinery stood idle for seven and a half months and then was subjected to heavy use. Accelerated production schedules during the peak season resulted in frequent setup changes on the machinery. Seemingly unavoidable confusion in scheduling runs resulted. Short runs and frequent setup changes caused inefficiencies in assembly and packaging as workers encountered difficulty relearning their operations.

For these reasons, Capt. Bob had urged Capt. Dave to adopt a policy of level monthly production in 2011. He pointed out that estimates of sales volume had usually proved to be reliable in the past. Purchase terms would not be affected by the rescheduling of purchases. The elimination of overtime wage premiums would result in substantial savings, estimated at $225,000 in 2011. Moreover, Capt. Bob firmly believed that significant additional direct labor savings, amounting to about $265,000, would result from orderly production. But a portion of the savings would be offset by higher storage and handling costs, estimated at $115,000 annually.

Capt. Dave speculated on the effect that level production might have on the company's funds requirements in 2011. He assumed that except for profits and fluctuations in the levels of inventories, accounts receivable, and accounts payable, funds inflows and outflows would be approximately in balance. To simplify the problem, Capt. Dave decided to assume that gross margin percentages would not vary significantly by month under either method of production. That is, cost of goods sold would be 70% of sales in each of the 12 months under seasonal production and would be 65.1% of sales in each of the 12 months under level production. The increased storage and handling costs of $115,000 would be included in operating expenses.

Action Plan

1) Construct Pro Forma Balance Sheet, Income Statement and Cash Budget for 2011 assuming Level Production.

2) Is the switch to level production feasible? Why or why not?

3) Would you recommend the switch?