THE SOUTH AMERICAN COFFEE COMPANY Data for Management Use In this case the problem of measuring performance

both for specific operating units and for functional areas, such as purchasing, is raised. The South American Coffee Company sold its own brands of coffee throughout the Midwest. Stock of the company, which was founded in 1903, was closely held by members of the family of the founder. The president and secretary-treasurer were members of the stockowning family and other management personnel had no stock interest. An organization chart of the company is shown in Exhibit 1. Sales policies and direction of the company were handled from the home office in Cincinnati, Ohio, and all salesmen reported to the sales manager through two assistants. The sales manager and the president assumed responsibility for advertising and promotion EXHiniT 1 Organization of the South American Coffee Company

PRESIDENT

SALES MANAGER

VICE-PRESIDENT MANUFACTURING

ASSISTANT GROCERY SALES

ASST CHAIN a INSTITUTIONAL SALES

SEC'Y-TREASURER

CREDIT

CONTROLLER

PURCHASING AGENT

FEDERAL TAXES

GENERAL ACCOUNTING

INTERNAL AUDIT

FINANCIAL ANALYSIS

PLANT MANAGER I

PLANT MANAGER 2

PLANT MANAGER 3

302

THE SOUTH AMERICAN COFFEE COMPANY 303 work. Roasting, grinding, and packaging of coffee was under tl)e direction of the vice-president of manufacturing, whose office was in Cincinnati. The company operated three roasting plants throughout the Mid-

west. Each plant operated on a profit and loss responsibility and the plant manager was paid a bonus on the basis of a per cent of his gross profit. Monthly profit and loss statements were prepared for each plant by the home office. The form of the profit and loss statement used is shown in Exhibit 2. Exhibit 3 shows the form of the company monthly income statement. Each month the plant manager was given a production schedule for the current month and a tentative schedule for the next succeeding month. Deliveries were made as directed by the home office. EXHIBIT 2 Operating Statement Plant No. 1-April, 1952 Net Sales ( Shipments at billing prices ) $74,462 Less: Cost of Sales Green CofFee-at contract cost $37,366 Roasting and Grinding: Labor $3,822 Fuel 2,478 Manufacturing Expenses 3,362 9,662 Packaging: Container $8,462 Packing Carton 914 Labor 1,226 Manufacturing Expenses 2,544 13,146 Total Manufacturing Cost $60,174 Gross Profit on Sales $14,288 All financial statements were prepared in the home office, and billing, credit, and collection were done there. Each plant had a small accounting office at which all manufacturing costs were recorded. Plant payrolls were prepared at the plant. Green coffee costs were supplied each plant, as indicated later, on a lot basis. The procurement of green coffee for the roasting operations of the South American Coffee Company was handled by a separate purchasing unit of the company. Because of the specialized problems and the need for constant contact with coffee brokers, the unit was

304 THE ROLE OF FINANCIAL ANALYSIS EXHIBIT 3

Income Statement

April, 1952

Net Sales Cost of Sales Green Coffee Roasting and Grinding Packaging Purchasing Department

Gross Profit

, $14,288 $ 247 $45,647

Selling Expenses: Commissions Salaries Advertising Sales Travel Other

Plants Green Coffee Total 1 2 3

$74,462 $12,374 $285,640 37,366 9,662 13,146 11,127

142,168 29,944 60,041 7,840 $60,174

$239,993

General Expenses: Salaries Bonuses to Plant Mgrs. Printing and Stationery Dues and Subscriptions Depreciation on F. & F. Other

Net Income before Federal Income Taxes Provision for Federal Income Taxes Net Income to Surplus

located in the section of New York City where the green coffee business was concentrated. The purchasing unit operated on an autonomous basis accounting-wise, keeping all records and handling all financial transactions pertaining to purchasing, sales to outsiders, and transfer to three company-operated roasting plants. The primary function of the purchasing unit was to have available for the roasting plants the variety of green coffees necessary to produce the blends which were to be roasted, packed, and sold to customers. This necessitated dealing in forty types and grades of coffee, which came from tropical countries all over the world.

THE SOUTH AMERICAN COFFEE COMPANY 305 Based on estimated sales budgets, purchase commitments were made which would provide for delivery in from three to fifteen months from the date that contracts for purchase were made. Although it was possible to purchase from local brokers for immediate delivery, such purchases usually were more costly than purchases made for delivery in the country of origin and, hence, these "spot" purchases were kept to a minimum. A most important factor in the situation was the market "know-how" of the purchasing executives,

who had to judge whether the market trend was apt to be up or down and had to make their commitments accordingly. The result of all this was that the green coffee purchasing unit was buying a range of coffees for advance delivery at various dates. At the time of actual delivery, the sales of the company's coffees might not have been going as anticipated when the purchase commitment had been made. The difference between actual deliveries and current requirements was handled through "spot" sales or purchase transactions in green coffee with outside brokers or other coffee roasters. As an example, the commitments of the company for Santos No. 4 (a grade of Brazilian coffee) might call for deliveries in the month of May of 20,000 bags ( of 132 pounds each ) . These deliveries would be made under fifty contracts which had been executed at varying prices from three to twelve months before the month of delivery. An unseasonal hot spell at the end of April had brought a slump in coffee sales, and it then developed that the company plants would require no more than 16,000 bags to meet their May requirements. The green coffee purchasing unit therefore had to decide whether to store the surplus in outside storage facilities (which would increase the cost) or to sell it on the open market. This example was typical of the normal operation. Generally speaking, the large volume of the company permitted it to buy favorably and to realize a normal brokerage and trading profit when selling in smaller lots to small roasting companies. Hence, the usual policy was to make purchase commitments on a basis of maximum requirements the usual result was that there was a surplus to be sold on a "spot" basis. In accounting for coffee purchases, a separate cost record was maintained for each purchase contract. This record was charged with payments for coffee purchased, with shipping charges, import

306 THE ROLE OF FINANCIAL ANALYSIS expenses, and similar items, with the result that net cost per bag was developed for each purchase. Thus, the fifty deliveries of Santos No. 4 coffee cited in the example would come into inventory at fifty separate costs. The established policy was to treat each contract on an individual basis. When green coffee was shipped to a plant, charge was made for the cost represented by the contracts that covered that particular shipment of coffee, with no element of profit or loss. When green coffee was sold to outsiders, the sales were likewise costed on a specific contract basis; there was resulting development of profit or loss on these transactions. The operating cost of running the purchasing unit was transferred in total to the central office, where it was recorded as an element in the general cost of coffee sales. For the past several years there has been some dissatisfaction on the part of plant managers with the method of computing gross profit subject to bonuses. This has finally led to a request from the president to the controller to study the whole method of reporting on results of plant operations and the purchasing operation.

Write a brief analysis, directed to the controller, of any changes you would propose in the present monthly reporting procedure, giving reasons. You should base your analysis on the assumption that the bonus to plant managers will be retained.