Sell or Process Further Decision
Sell or process further decision is the option whether to sell the product now or process further to earn more revenue. We think that earning additional revenue is good for the company, however, we must ensure that it will overcome the additional cost as well. Additional process will require more resources and costs, so we need to compare the profit margin between selling now and later.
Moreover, we must try to maximize the return from our investment. Additional process may require additional investment such as machinery. Due to these factors, we have to use the sell or process further method to make the right decision.
This case usually happens in the joint product where one or more output can be developed and generate extra revenue. The joint products have the same production cost up to the split point where the sell or process further takes place. The products can be sold at the split point but sometimes it is more profitable by developing them further.
Company A is producing both product X and Y which is the joint product. After both products split, the company can sell both products at $20 and $30 respectively. However, we will be able to increase the price of Y to $ 40 per unit if we process further, and it will cost $ 1,000,000 to get them complete. The quantity of X and Y is 60,000 units and 80,000 units.
Should the company sell both products now or process further to gain more revenue.
If we sell both products without any additional work, the sale should be:
Sale amount = ($20 * 60,000 units) + ($30 * 80,000 units)
Sale amount = $ 1,200,000 + $ 2,400,000 = $ 3,600,000
If we decide to process further, the sale would be:
Sale amount = ($20 * 60,000 units) + ($40 * 80,000 units)
Sale amount = $1,200,000 + $3,200,000 = $ 4,400,000
However, we need to spend an additional cost of $ 1,000,000 so the net sale is only $3,400,000 which is less than the original sale amount at the split point.
|Current Value of product||We have to access the market value of our unprocessed product. How much the customer willing to pay for this kind of product. It will more realistic if we can sell products now rather than the future, as time changes, the higher the risk we get. If the current price and the futures price is not much different, the company may consider to sell them now and get the cash quick rather than wait for a higher price and incur an additional cost.|
|Expected Value if we process further||The expected value of our product must be carefully studied, as it will be our revenue after we decide to do the extra work. The company needs to know any factors which will impact the future price as well. If we decide to process further then the price drop, we will lose the money.|
|Additional cost for extra work||The additional revenue must exceed the additional cost, otherwise, we should sell them in the first place. There are no reasons to work further and receive the same or less amount of revenue.|
In a sell or process further decision, management should process when:
- The additional revenue is more than the additional process cost. We may need to have a proper contract with customers to lock the price.
- The additional profit margin should be equal or higher than the original margin. We may process with a lower margin when the company has surplus cash available.
- We have enough resources to complete the additional work.