Alokesh DuttaCase Study: Cost Audit for Pristine Plastics Ltd
Company Overview:
Pristine Plastics Ltd., established in 2005, is a medium-sized manufacturing unit located in Nagpur, Maharashtra. The company specializes in producing plastic containers and packaging products for various industries, including pharmaceuticals, FMCG, and agriculture. Over the years, Pristine Plastics Ltd. has grown steadily, but recently faced challenges in maintaining profitability due to rising raw material costs, underutilization of capacity, and operational inefficiencies.
In the financial year 2023-24, the company appointed **Dutta & Partners Cost Accountants** for conducting a cost audit to assess the current cost structure and identify areas for improvement.
Audit Period:
April 2023 to March 2024
Objectives of the Cost Audit:
1. To analyze the cost structure of the company, including material costs, labor costs, and overheads.
2. To identify inefficiencies in production and suggest cost-saving measures.
3. To assess the capacity utilization of the plant and recommend measures to optimize the same.
4. To evaluate the pricing policy and its impact on profitability.
5. To provide recommendations for improvement in operational efficiency.
Key Findings of the Cost Audit:
1. Material Costs:
Material Consumption: The company primarily uses polypropylene (PP) as the raw material for manufacturing plastic containers. The total material consumption for the year was 600 metric tons at an average cost of ₹100,000 per metric ton.
Material Yield: A material yield of 85% was observed, meaning 15% of the raw material was wasted in the production process, which is higher than the industry standard of 10%.
Observation: The high wastage level was due to improper handling during the extrusion and molding processes.
2. Labor Costs:
Direct Labor Cost: The total direct labor cost for the year amounted to ₹15 million, with 80 workers employed in the production process. The average labor productivity was 7,500 units per worker per month.
Observation: While labor costs were competitive, there was an opportunity to improve labor productivity by introducing more automated machinery and training programs for workers to reduce manual intervention.
3. Overheads:
Factory Overheads: The total overheads were ₹30 million, including power, maintenance, and administrative costs.
Power Consumption: Power costs constituted 30% of the total overheads, which was primarily due to the use of outdated machinery.
Observation:The plant was operating at 65% capacity, leading to higher fixed costs per unit. The underutilization was primarily due to erratic demand from clients and frequent machine breakdowns.
4. Pricing Policy:
Current Pricing: The company was selling its plastic containers at an average price of ₹12 per unit, with a contribution margin of ₹4 per unit.
Observation: While the pricing was competitive, the profit margin was under pressure due to rising raw material costs and operational inefficiencies.
Recommendations:
1. Reduction in Material Wastage:
– Introduce lean manufacturing practices such as Total Productive Maintenance (TPM) and
Kaizen to reduce material wastage during production.
Implement a scrap recycling process to reuse the 15% waste generated during production. This could bring the material yield closer to the industry standard of 90%, saving ₹9 million annually.
2. Improve Labor Productivity:
Introduce automation in key production processes such as extrusion and packaging to reduce manual intervention.
Provide periodic training for workers to enhance their skills and reduce production downtime. Increasing labor productivity by 10% could lead to an additional 720,000 units per year, contributing to higher revenue.
3. Upgrade Machinery and Optimize Capacity:
Replace outdated machinery with energy-efficient alternatives to reduce power costs by at least 10%, saving ₹9 million annually.
Focus on improving capacity utilization by enhancing production scheduling and demand forecasting. Increasing capacity utilization to 80% could reduce fixed costs per unit and improve profitability by 5%.
4. Revisit Pricing Strategy:
Considering the rising cost of raw materials, the company should review its pricing policy. By implementing a cost-plus pricing model, the company can ensure a profit margin of 10% even when material costs fluctuate.
Explore value-added products like biodegradable plastic containers, which have higher market demand and can command a premium price of ₹15 per unit, leading to an increased contribution margin.
5. Diversify Client Base:
Pristine Plastics Ltd. should focus on expanding its client base beyond the existing industries. Entering new sectors like food packaging and medical supplies could provide a buffer against erratic demand from its current clients.
Implement customer relationship management (CRM) tools to maintain better demand forecasting and enhance customer retention.
Conclusion:
The cost audit of Pristine Plastics Ltd. revealed several opportunities for cost reduction and operational improvement. By implementing the recommended strategies, the company could potentially save ₹18 million annually through reduced material wastage and power consumption. Additionally, improving labor productivity and optimizing capacity utilization could result in higher profitability and a more sustainable business model.
By addressing inefficiencies, revisiting pricing strategies, and exploring new markets, Pristine Plastics Ltd. is poised for improved profitability and long-term growth.
Note : All names and figures are hypothetical but case study is based on actual analysis
