Special orders can be a game-changer for businesses with excess capacity. They offer a chance to boost profits, but it's not always a no-brainer. You've got to weigh the pros and cons carefully, looking at both numbers and non-financial factors.
When deciding on a special order, start by checking if you've got the capacity. Then, crunch the numbers to see if it'll actually make you money. Don't forget to think about how it might affect your regular customers and your company's reputation. It's all about making smart choices for your business.
Evaluating and Determining Whether to Accept or Reject a Special Order
Capacity requirements for special orders
- Determine available production capacity
- Calculate current capacity utilization percentage of total capacity being used (80%)
- Identify excess capacity that can be used for the special order remaining unused capacity (20%)
- Assess the impact on regular production
- Determine if the special order will displace regular production lead to reduced output of standard products
- Consider the opportunity cost of lost regular sales foregone profit from standard products not produced
- Identify incremental costs associated with the special order
- Variable costs (direct materials, direct labor, variable manufacturing overhead)
- Additional fixed costs incurred specifically for the special order setup costs, special equipment rentals
- Analyze the effect on the company's cost structure
- Determine if the special order will lead to economies of scale lower per-unit costs due to increased production volume
- Consider the potential for cost inefficiencies due to production disruptions retooling, changeovers, learning curve effects
- Utilize break-even analysis to determine the minimum quantity needed to cover fixed costs
Profitability of special orders
- Identify relevant revenues
- Selling price of the special order quoted price per unit
- Subtract any discounts or allowances (volume discounts, promotional offers)
- Determine relevant costs
- Incremental costs associated with the special order additional direct materials, labor, and variable overhead
- Opportunity costs of accepting the special order lost contribution margin from displaced regular sales
- Calculate the contribution margin of the special order
- Relevant revenues minus relevant costs
- Formula: $Contribution Margin = Selling Price - Variable Costs$
- Assess the impact on overall profitability
- Compare the contribution margin of the special order to the regular product mix per-unit contribution margin
- Determine if the special order will increase total profits by generating a positive incremental contribution margin
- Apply marginal costing to focus on variable costs for short-term decision-making
Qualitative factors in order decisions
- Consider the impact on customer relationships
- Assess the potential for future business with the special order customer repeat orders, referrals
- Evaluate the risk of alienating regular customers perception of favoritism, reduced product availability
- Analyze the effect on the company's reputation
- Determine if accepting the special order aligns with the company's brand image quality, exclusivity, consistency
- Consider potential negative publicity or market perception perceived as desperate, inconsistent pricing
- Assess the impact on employee morale and motivation
- Evaluate the effect of the special order on workload and job satisfaction overtime, stress, job complexity
- Consider the potential for employee burnout or turnover due to increased demands or perceived unfairness
- Review legal and contractual obligations
- Ensure compliance with existing contracts and agreements (exclusivity clauses, minimum order quantities)
- Identify any potential legal risks associated with accepting the special order (intellectual property, confidentiality, liability)
Decision-making process
- Gather relevant financial and non-financial information
- Analyze quantitative data using techniques such as marginal costing and break-even analysis
- Consider qualitative factors and their potential long-term impact
- Evaluate opportunity costs of accepting or rejecting the special order
- Make an informed decision based on a comprehensive assessment of all factors