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Costs and Revenues

Costs and Revenues. The webinar will cover: 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

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Costs and Revenues

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  1. Costs and Revenues The webinar will cover: • 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.

  2. Calculating contribution Selling price – Variable costs = Contribution Contribution is a key element of short-term decision making Contribution per unit is required for break-even calculations.

  3. 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:

  4. 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:

  5. 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:

  6. 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:

  7. Total contribution Or: £12.60 x 10,000 units = £126,000

  8. 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. Variable element: Fixed element: £64,800 – (150,000 x £0.25) = £27,300

  9. 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.

  10. 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. Variable element: Fixed element: £121,000 – (18,000 x £4.50) = £40,000

  11. 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.

  12. Poll Question 1 Calculate the variable cost per unit (to the nearest penny) for the following product: A. £13.15 B. £11.71 C. £9.40 D. £19.65 E. £15.71

  13. Poll Question 1 - Answer Calculate the variable cost per unit (to the nearest penny) for the following product: A. £13.15 B. £11.71 C. £9.40 D. £19.65 E. £15.71

  14. Break-even Sales revenue > Costs = Profit Sales revenue < Costs = Loss Break-even point: Sales revenue = Costs

  15. Calculating break-even The calculation of break-even uses the total fixed costs and the contribution per unit Break-even in units:

  16. 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:

  17. 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

  18. Student Example 2 The following information relates to a single product: Calculate: (a) Contribution per unit (b) Break-even point in units (c) Break-even point in revenue.

  19. Student Example 2 - Answer • 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 • Break-even point in units £143,000 ÷ £22 = 6,500 units • Break-even point in revenue 6,500 units x £52 = £338,000

  20. 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

  21. 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:

  22. Example – Calculating target profit in units Sales revenue required to achieve the target profit is calculated as 11,500 units x £38.40.

  23. 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

  24. Student Example 3 - Answer • Sales volume to achieve target profit (b) Sales revenue to achieve target profit 7,300 units x £52 = £379,600

  25. 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:

  26. 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: 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:

  27. Using the CS Ratio The sales revenue required break-even is calculated as: The sales revenue required to achieve target profit is calculated as:

  28. 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: The sales revenue required to achieve target profit is calculated as:

  29. Poll Question 2 The following information relates to a single product The CS ratio is: A. 0.085 B. 0.423 C. 2.364 D. 0.577

  30. Poll Question 2 - Answer The following information relates to a single product The CS ratio is: A. 0.085 B. 0.423 C. 2.364 D. 0.577

  31. 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

  32. 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

  33. Margin of Safety % Margin of safety is often expressed as a percentage. The formula is:

  34. 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:

  35. 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: • Margin of safety in units • Margin of safety in sales revenue (c) Margin of safety %.

  36. 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%

  37. Making decisions using contribution and break-even • Identifying the sales revenue required for a new project to break-even or to reach a target profit • Evaluating the effect of increases in production volume and the impact on fixed costs • ‘What-if’ scenarios • Assessing alternative projects or major changes to production processes • Assessing the viability of a new business • Identifying the expected levels of profit or loss at different activity levels.

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