Transcript Slide 1

Costs and Revenues
The webinar will cover:
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Calculating contribution
Calculating break-even in units and sales revenue
Break-even and target profit
Calculating and using the contribution to sales ratio
Margin of safety and margin of safety percentage
Making decisions using break-even analysis.
Calculating contribution
Contribution is a key element of short-term decision
making
Selling price – Variable costs = Contribution
Contribution per unit is required for break-even
calculations.
Example - Calculating contribution
Product DTX has a selling price of £38.40 per unit.
Each unit requires 1.25 kg of material at £7.20 per kg and 1.4 hours at £12 per
hour. Fixed costs are £100,800.
Contribution per unit is:
Selling price
Less:
Material (1.25 kg x £7.20)
£
38.40
9.00
Labour (1.4 hrs x £12)
16.80
Contribution per unit
12.60
Example - Calculating contribution
Product DTX has a selling price of £38.40 per unit.
Each unit requires 1.25 kg of material at £7.20 per kg and 1.4 hours at £12 per
hour. Fixed costs are £100,800.
Contribution per unit is:
Selling price
Less:
Material (1.25 kg x £7.20)
£
38.40
9.00
Labour (1.4 hrs x £12)
16.80
Contribution per unit
12.60
Example - Calculating contribution
Product DTX has a selling price of £38.40 per unit.
Each unit requires 1.25 kg of material at £7.20 per kg and 1.4 hours at £12 per
hour. Fixed costs are £100,800.
Contribution per unit is:
Selling price
Less:
Material (1.25 kg x £7.20)
£
38.40
9.00
Labour (1.4 hrs x £12)
16.80
Contribution per unit
12.60
Example - Calculating contribution
Product DTX has a selling price of £38.40 per unit.
Each unit requires 1.25 kg of material at £7.20 per kg and 1.4 hours at £12 per
hour. Fixed costs are £100,800.
Contribution per unit is:
Selling price
Less:
Material (1.25 kg x £7.20)
£
38.40
9.00
Labour (1.4 hrs x £12)
16.80
Contribution per unit
12.60
Total contribution
Selling price (£38.40 x 10,000 units)
£
384,000
Less:
Material (£9 x 10,000 units)
Labour (£16.80 x 10,000 units)
90,000
168,000
Total contribution
126,000
Or:
£12.60 x 10,000 units = £126,000
Total contribution
£
126,000
Less:
Fixed costs
100,800
Total profit
25,200
Example – High low method
Semi-variable production costs have been calculated as £64,800 at an activity
level of 150,000 units and £59,300 at an activity level of 128,000 units.
High
£
64,800
Units
150,000
Low
59,300
128,000
5,500
22,000
Difference
Variable element:
£5,500
22,000 units
= £0.25 per unit
Fixed element:
£64,800 – (150,000 x £0.25) = £27,300
Student Example 1
A company has identified that the cost of labour is semi-variable. When 12,000
units are manufactured the labour cost is £94,000 and when 18,000 units are
manufactured the labour cost is £121,000.
Calculate the variable and fixed cost of labour.
High
£
121,000
Units
18,000
Low
94,000
12,000
Difference
27,000
6,000
Student Example 1 - Answer
A company has identified that the cost of labour is semi-variable. When 12,000
units are manufactured the labour cost is £94,000 and when 18,000 units are
manufactured the labour cost is £121,000.
Calculate the variable and fixed cost of labour.
High
£
121,000
Units
18,000
Low
94,000
12,000
Difference
27,000
6,000
Variable element:
£27,000
6,000 units
= £4.50 per unit
Fixed element:
£121,000 – (18,000 x £4.50) = £40,000
Identifying cost behaviour
• When the cost divided by the units gives the same answer at both
activity levels then the cost is variable
• When the cost is identical at both activity levels then the cost is fixed
• When the cost divided by the units gives a different figure at each
activity level then the cost is semi-variable.
Poll Question 1
Calculate the variable cost per unit (to the nearest penny) for the following
product:
4,000
units
£
6,500
units
£
Material
22,400
36,400
Labour
30,200
39,700
Production expenses
26,000
26,000
78,600
102,100
A.
£13.15
B.
£11.71
C.
£9.40
D.
£19.65
E.
£15.71
Poll Question 1 - Answer
Calculate the variable cost per unit (to the nearest penny) for the following
product:
4,000
units
£
6,500
units
£
Material
22,400
36,400
Labour
30,200
39,700
Production expenses
26,000
26,000
78,600
102,100
A.
£13.15
B.
£11.71
C.
£9.40
D.
£19.65
E.
£15.71
Break-even
Sales revenue > Costs = Profit
Sales revenue < Costs = Loss
Break-even point: Sales revenue = Costs
Calculating break-even
The calculation of break-even uses the total fixed costs and the
contribution per unit
Break-even in units:
Fixed costs (£)
Contribution per unit (£)
= Break-even in units
Example – Break-even in units
Product DTX has a selling price of £38.40 per unit and total variable
costs of £25.80 per unit. Fixed costs are £100,800.
The break-even point in units is:
£100,800
(£38.40 - £25.80)
= 8,000 units
Break-even in sales revenue
Break-even is: Units x Selling Price per unit
Using the previous example where break-even has been
calculated as 8,000 units and the selling price is £38.40 per unit.
8,000 units x £38.40 = £307,200
Student Example 2
The following information relates to a single product:
Sales
Variable costs:
Material
Labour
Expenses
Fixed costs:
Overheads
Profit
8,125 units
£
422,500
87,750
125,125
30,875
143,000
35,750
Calculate:
(a) Contribution per unit
(b) Break-even point in units
(c) Break-even point in revenue.
Student Example 2 - Answer
(a) Contribution per unit
Selling price per unit: £422,500 ÷ 8,125 = £52
Variable cost per unit: (£87,750 + £125,125 + £30,875) ÷ 8,125 = £30
Contribution per unit: £52 - £30 = £22
(b) Break-even point in units
£143,000 ÷ £22 = 6,500 units
(c) Break-even point in revenue
6,500 units x £52 = £338,000
Target profit
Break-even analysis can be used to identify the number of units that
need to be sold for the business to reach their desired or target level
of profit
Fixed costs (£) + Target profit (£)
Contribution per unit (£)
= units to be sold
Example – Calculating target profit in units
Product DTX has a selling price of £38.40 per unit and total variable
costs of £25.80 per unit. Fixed costs are £100,800.
The company requires a target profit of £44,100.
The number of units to be sold to achieve the target profit is:
£100,800 + £44,100 = 11,500 units
(£38.40 - £25.80)
Example – Calculating target profit in units
Sales
Variable costs:
Material
Labour
Fixed costs:
Overheads
Profit
Unit
price
£
38.40
11,500
units
£
441,600
9.00
103,500
16.80
193,200
100,800
44,100
Sales revenue required to achieve the target profit is calculated as
11,500 units x £38.40.
Student Example 3
The following information relates to a single product:
Selling price per unit
£52.00
Contribution per unit
£22.00
Fixed overheads
£143,000
Target profit
£17,600
Calculate:
(a)
Sales volume to achieve target profit
(b)
Sales revenue to achieve target profit
Student Example 3 - Answer
(a) Sales volume to achieve target profit
£143,000 + £17,600
= 7,300 units
£22
(b) Sales revenue to achieve target profit
7,300 units x £52 = £379,600
Contributions to sales ratio
The contribution to sales ratio or CS ratio expresses contribution as a
proportion of sales
It can be calculated using the selling price and contribution per unit or
the total sales revenue and total contribution.
It is calculated as:
Contribution per unit (£) = CS ratio
Selling price per unit (£)
Example – Calculating CS Ratio
Product DTX has a selling price of £38.40 per unit and contribution of
£12.60 per unit
The CS ratio is:
£12.60 = 0.328
£38.40
At a sales volume of 10,000 units product DTX has sales revenue of
384,000 and contribution of £126,000.
The CS ratio is:
£126,000 = 0.328
£384,000
Using the CS Ratio
The sales revenue required break-even is calculated as:
Fixed costs (£)
= sales revenue to break-even
CS ratio
The sales revenue required to achieve target profit is calculated as:
Fixed costs (£) +
Target profit (£)
CS ratio
= sales revenue to
achieve target profit
Example – Using the CS ratio
Product DTX has a selling price of £38.40 per unit and contribution of
£12.60 per unit. Fixed costs are £100,800.
The company requires a target profit of £44,100. The CS ratio is
0.328.
The sales revenue required break-even is calculated as:
£100,800 = £307,317
0.328
The sales revenue required to achieve target profit is calculated as:
£100,800 + £44,100
0.328
= £441,768
Poll Question 2
The following information relates to a single product
Sales
Variable costs:
Material
Labour
Expenses
Fixed costs:
Overheads
Profit
8,125
units
£
422,500
87,750
125,125
30,875
143,000
35,750
The CS ratio is:
A.
0.085
B.
0.423
C.
2.364
D.
0.577
Poll Question 2 - Answer
The following information relates to a single product
Sales
Variable costs:
Material
Labour
Expenses
Fixed costs:
Overheads
Profit
8,125
units
£
422,500
87,750
125,125
30,875
143,000
35,750
The CS ratio is:
A.
0.085
B.
0.423
C.
2.364
D.
0.577
Margin of safety (MOS)
Margin of safety is the excess of budgeted sales over break-even
sales
It is calculated as:
Budgeted volume – Break-even volume = Margin of safety in units
Margin of safety can also be expressed in sales revenue:
Margin of safety in units x Selling price per unit
Example – Margin of safety
Product DTX has a selling price of £38.40 per unit and total variable
costs of £25.80 per unit. Fixed costs are £100,800. Break-even has
been calculated as 8,000 units and the company has budgeted to sell
12,000 units.
The margin of safety in units is:
12,000 units – 8,000 units = 4,000 units
The margin of safety in sales revenue is:
4,000 units x £38.40 = £153,600
Margin of Safety %
Margin of safety is often expressed as a percentage.
The formula is:
Budgeted volume –
Break-even volume
Budgeted volume
x 100 = MOS %
Example – Margin of Safety %
Where budgeted volume is 12,000 units, break-even is 8,000 units
and margin of safety is 4,000 units, margin of safety percentage is:
12,000 units – 8,000 units x 100
= 33%
12,000 units
Margin of safety in units x 100
Budgeted volume
= MOS %
Student Example 4
The following information relates to a single product:
Selling price per unit
£52.00
Contribution per unit
£22.00
Fixed overheads
£143,000
Budgeted sales
8,125 units
Calculate:
(a) Margin of safety in units
(b) Margin of safety in sales revenue
(c) Margin of safety %.
Student Example 4 - Answer
(a)
Margin of safety in units
8,125 units – 6,500 units = 1,625 units
(b)
Margin of safety in sales revenue
1,625 units x £52 = £84,500
(c)
Margin of safety %
(1,625 units ÷ 8,125 units) x 100 = 20%
Making decisions using contribution and
break-even
1. Identifying the sales revenue required for a new project to breakeven or to reach a target profit
2. Evaluating the effect of increases in production volume and the
impact on fixed costs
3. ‘What-if’ scenarios
4. Assessing alternative projects or major changes to production
processes
5. Assessing the viability of a new business
6. Identifying the expected levels of profit or loss at different activity
levels.