Omega Medical Supplies Pte Ltd (OMS) is a small but growing manufacturer of medical equipment. Due to its small set-up, the company does not have a sales force of its own, but relies entirely on independent sales agents to market its products. The independent sales agents are paid a commission of 15% of sales. This is reflected in the budget for the new financial year ending 31 December 2022, as follows: ($'000) Sales Cost of goods sold Variable Fixed Gross profit Selling, general and administrative expenses Agents' commissions Fixed advertising expenses Fixed general and administrative expenses Profit before interest and taxes Fixed interest expense Profit before taxes Tax expense Profit after tax 7,200 2,340 2,400 120 1,800 ($'000) 16,000 9,540 6,460 4,320 2,140 540 1,600 272 1,328
Master Budget
A master budget can be defined as an estimation of the revenue earned or expenses incurred over a specified period of time in the future and it is generally prepared on a periodic basis which can be either monthly, quarterly, half-yearly, or annually. It helps a business, an organization, or even an individual to manage the money effectively. A budget also helps in monitoring the performance of the people in the organization and helps in better decision-making.
Sales Budget and Selling
A budget is a financial plan designed by an undertaking for a definite period in future which acts as a major contributor towards enhancing the financial success of the business undertaking. The budget generally takes into account both current and future income and expenses.
Compute the degree of operating leverage that OMS would expect to have as at 31 December 2022 under the following scenarios:
(i) Using independent sales agents’ commission at 15%.
(ii) Using independent sales agents’ commission at 20%.
(iii) Using the company’s own hired sales team.
Use operating income before taxes in the above computation.
![Omega Medical Supplies Pte Ltd (OMS) is a small but growing manufacturer of medical
equipment. Due to its small set-up, the company does not have a sales force of its own, but
relies entirely on independent sales agents to market its products.
The independent sales agents are paid a commission of 15% of sales. This is reflected in the
budget for the new financial year ending 31 December 2022, as follows:
(S'000)
(S'000)
16,000
Sales
Cost of goods sold
Variable
Fixed
7,200
9,540
6,460
2.340
Gross profit
Selling, general and administrative expenses
Agents' commissions
Fixed advertising expenses
Fixed general and administrative expenses
Profit before interest and taxes
2,400
120
1,800
4,320
2,140
Fixed interest expense
Profit before taxes
540
1,600
Тах еxpense
272
Profit after tax
1,328](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F0ed910c2-ce17-44bc-a678-6e4f25cfc26f%2F8ef70c9b-c051-4640-a0c1-34d89451e989%2Fsssz41a_processed.jpeg&w=3840&q=75)
![Subsequent to the approval of the budgets for the year ending 31 December 2022, OMS was
informed that independent sales agents demanded for an increase in commission rate to 20%
for 2022 to cover for advertising, travel and other promotional costs. This effectively rendered
the approved budgets invalid.
The founder of OMS, Denzel was indignant that they had to be subjected to the unfounded
request by the independent sales agents, and commissioned an urgent study of hiring its own
sales team.
After a detailed analysis, the financial controller proposed to engage the company's own sales
team, providing a 7.5% sales commission and a base salary, which is comparable to market
rates. However, the company will have to handle all advertising and promotional activities
internally.
Under the new proposal, fixed costs would increase by $2,400,000 (see below for details), but
this would be better than having to pay the independent sales agents a commission of
$3,200,000 (20% of $16,000,000).
($'000)
Salaries of sales team
Sales manager
Sales persons
Travel and entertainment
100
600
400
Advertising and promotion
1,300
2,400
Denzel was very pleased with the proposal, commenting that the $2,400,000 is exactly the same
as what the company would have paid under the 15% commission rate. In addition, there would
be additional savings of $75,000 from auditing fees paid to verify the agents' sales reports. In
other words, general and admin expenses will decrease by $75,000. He has asked the financial
controller to tidy up the proposal quickly and get the new budget approved.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F0ed910c2-ce17-44bc-a678-6e4f25cfc26f%2F8ef70c9b-c051-4640-a0c1-34d89451e989%2F4fh70uq_processed.jpeg&w=3840&q=75)
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