Cost System Analysis
We were tasked with analyzing Sippican’s costing structure to determine if activity based costing can give a clearer picture of the company’s true costs. Currently, Sippican assigns overhead costs at a flat rate across all three products.
Our analysis of cost and profitability reveals a dramatic difference between the cost to produce each product as reported using Sippican’s traditional costing structure and the detailed analysis using time driven activity based costing. Under the traditional costing structure, all three roducts are reported to have a positive gross profit margin. Pumps are reported to be the least profitable product with a 5% gross profit margin while flow controllers are reported to be the most profitable product with a gross margin of 38%.
Our time based activity based costing analysis provides a clear picture of costs as they relate to the production of each specific product. Where flow controllers were thought to be the most profitable product, activity based costing reveals that flow controllers are actually produced at a negative margin.
The shift in cost and profitability for flow controllers is found to be related to the substantial costs to engineer the product and high cost of setup.
Recently, Sippican was forced to lower prices on pumps to compete in the marketplace. Our analysis reveals that Sippican could improve their situation by allocating unused capacity to pump production.
The price of flow controllers was increased recently without any negative impact on demand. Sippican could improve the performance of their flow controller activities by further raising the price of flow controllers.