Explaining accounting and finance can be pretty dull. That’s a problem, if you need to learn accounting or finance.
On a plane from St. Louis to Seattle this Spring, I decided to try and fix the problem. What if I could wrap some accounting concepts inside of a quirky (funny?) short story. My goal here is to present some information, then add another step in the story. So, when you get to the end, you’ve been reminded of an accounting concept- but you’ve received the information in a light-hearted way.
Anyway, that’s the goal here….enjoy!
February in the Midwest- probably the toughest weather month of the year, Greg thought. He stomped his feet on the mat to get rid of the slush and unlocked the office door.
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Greg’s business, MountainView Clothing, made specialty shirts, pants and shorts. Their customers were serious outdoor people. Clients bought MountainView gear for its durability and quality.
His mission today (If he decided to accept it) was a sell of process further issue. Greg had two choices: He could sell a product as is- with no further production. There was customer demand for this “as is” product. He could, instead, add some features to the product and sell it for a higher price.
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“Hi, Tony”. Greg spotted Tony over by the kitchen.
“Oh, hey Greg. How was your weekend? The weather was bad, so I binge-watched Spougebob Squarepants….loved it!”.
Greg laughed and headed into his office. Tony has always been a connoisseur of Nickelodeon shows.
The month of February was the company’s busiest production month. The firm shipped a lot of clothing in early March to meet the spring demand for outdoor gear. Greg’s best-selling product was TundraTough hiking shorts.
Producing TundraTough was alittle tricky, Greg thought as he sipped his coffee. His vendor provided a unique nylon and cotton blend of fabric. Greg’s staff used customized machines to cut and sew the fabric into shorts. Some components, such as zippers, were added manually.
A strong odor from the just outside the door distracted Greg. John, another employee, was cooking in the small kitchen. Greg strolled in.
“Hey Greg- yea, still using a lot of garlic. I guess you can smell it from your office.”
“No problem!”, Greg said. “Hope you had a good weekend. I’ll be in there if you need me.”
Greg headed back. He pulled up his budget plans for Tundra Tough. His cost per pair of pants was $80. The pants sold at a price of $95, for a $15 profit. A quick calculation told him that the profit margin (profit / sale price) was 15.8%. He peered out the window….
Aggh! Greg gagged and his eyes watered. Was John curing meat in there? The odor of garlic was overpowering. He turned on a fan in the office and went back to his spreadsheet.
MountainView had recently surveyed their clients about what they wanted in terms of outdoor gear. Greg cracked open a window and opened the results of the survey.
The number one request from customers was a reinforced version of TundraTough hiking shorts. Specifically, they wanted the pant seat and the seams up the sides to be even stronger. Under particularly heavy use, hikers and climbers put a lot of strain of their clothing. Sometimes the stitching wouldn’t hold up.
Wow- it’s cold. He reached over to close the window. The smell was tolerable now. Greg figured he was safe- until John started making lunch.
Based on the results of the survey, Greg had designed and sourced an even more sturdy material to sew into the pant seat and along the side seam of the pant. The additional support was sewn between two layers of pant material, so the user didn’t notice.
The new line of pants was called RidgeKing. The cost of the shorts (with the extra labor and materials) was $100. Given the competition MountainView faced, Greg could only price the shorts at $110. His research indicated that demand would fall sharply above $110 per pair.
Greg left his office to head over to the production building. Humm- at $110, the profit margin was on 9.1%. That was less than the company earned on TundraTough.
Walking through the parking lot, a sticker on the back of a car made him stop. It was one of those stick figure stickers. They normally had a stick figure for Dad, Mom and the kids. Greg always saw them in descending order of height- kinda cute.
On this sticker, the Mom stick figure had been removed. In its place was the word “available”. Well, some people use Match.com- some use direct marketing, Greg thought. A little jarring, but it might be effective.
He spent about 20 minutes in the factory reviewing the new material for RidgeKing. He convinced himself that the amount of fabric needed per pair was correct. As a result, his total cost of $100 per pair was accurate.
He headed back to the office. To serve his customers, he needed to provide both styles of shorts. However, a pair of RidgeKing shorts generated $5 less in profit ($15 – $10) than a TundraTough pair.
Greg pulled up a spreadsheet. Last year, he has sold 10,000 pairs of TundraTough shorts. At a $15 profit, his total profit from the line of shorts was ($15 X 10,000 pairs = $150,000).
OK, we have only so much production capacity available, he thought. He wanted to meet the needs of his customers- but not reduce his total profit. If he was going to make a new product, he wanted to earn the same profit as the TundraTough shorts would earn.
At only a $10 profit, it would only makes sense to produce RidgeKing if he was able to sell 15,000 pairs. At that sales level, the total profit would be ($10 X 15,000 = $150,000).
If he couldn’t reach that 15,000 sales level, he might as well produce and sell only the TundraTough. Greg had more capacity to produce and sell more TundraTough- but he wanted to meet the needs of customers who wanted to more expensive shorts.
He glanced at his watch. Maybe John will go out to lunch and not cook…..
Does this style of writing help you solve a problem? I’d love to hear from you.
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
(website and blog) http://www.accountingaccidentally.com/
(you tube channel) kenboydstl
Image: Caspar Girl, Russian Gulch hike, “Short Cut”, (CC BY 2.0)