Question 11.8: Goodsports Ltd is a retail shop that operates through three ...
Goodsports Ltd is a retail shop that operates through three department all in the same premises. The three departments occupy roughly equal areas of the premises. The trading results for the year just ended showed the following:
|
Total $’000 |
Sports equipment
$’000 |
Sports clothes
$’000 |
General clothes $’000 |
|
| Sales | 534 | 254 | 183 | 97 |
| Costs | 482 | 213 | 163 | 106 |
| Profit/(loss) | 52 | 41 | 20 | (9) |
It seems that general cloths department closed, the business would be more profitable, by $9,000 a year, assuming last year’s performance to be a reasonable indication of future performance.
When the costs are analysed between those that are variable and those that are fixed, however, the following results are obtained:
|
Total $’000 |
Sports equipment $’000 |
Sports clothes $’000 |
General clothes $’000 |
|
| Sales | 534 | 254 | 183 | 97 |
| Variable costs | 344 | 167 | 117 | 60 |
| Contribution | 190 | 87 | 66 | 37 |
| Fixed costs (rent, etc.) | 138 | 46 | 46 | 46 |
| Profit/(loss) | 52 | 41 | 20 | (9) |
From this analysis it is obvious that closing the general clothes department, without any other development, would make the business worse off $37,000 (the department’s contribution). The department should not be closed, because it makes a positive contribution. The fixed costs would continue whether the department closed or not. As the above analysis shows, distinguishing between variable and fixed costs can make the picture a great deal clearer.
Other development that might need to be considered include the following:
- Expanding the other departments or replacing the general clothes department with a completely new activity. This would make sense only if the space currently occupied by the general clothes department could generate contributions totalling at least $37,000 a year.
- Subletting the space occupied by the general clothes department. Once again, this would need to generate a net figure of $37,000 a year to make it more financially beneficial than keeping the department open.
- There may be advantages in keeping the department open even if it generated no contribution (assuming no other use for the space). This is because customers attracted to the general clothing range may then shop at one of the other departments. By the same token, a sub-tenant business might attract customers to the shop (or drive them away).