A manufacturing company is interested for one-year term bank loan of one hundred crores per annum which is producing goods worth 450 crores every year. Bank offers various commercial interest rates between 9.5 (min) to 11 (max) percent on the bank loan.
It is estimated that the company is having unfavorable yield variance of 15 percent per year which looks abnormal if we look at the operations of other company in the same industry. I do not understand why this company is so interested in bank loan. I do not think it should borrow money but I do think it should go for an internal analysis. Unnecessary interest expense will incur if this company takes bank loan from banks.
For example if the company takes 100 crores in a calendar year, the differential interest expense (probably saving) would be down by 1.5% (max-min) which is 1.5 crores. That is a great figure if we can really save! We have to ask ourselves now- should this company go for bank loan? Can this company manage the need for money in other mode of financial accommodation?
I think, if this company continuously reduce its yield variance by 2 percent per year, it might not think for bank loan. 2% on 450 crores will amount to 9 crores of savings!! What the hell are they thinking then! From Managerial Accounting point of view, I will emphasize on the analysis as to how unnecessary cost can be curtailed. Cost control is much more important than reduction of costs as because reduction may be pessimistic in respect of quality, timeliness and other respects.
My suggestion to this company is to think further before borrowing money and to pay more attention on good manufacturing practices and to reduce waste and increasing efficiency of the production process and other factors of production.