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.

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 38.40 Less: Material (1.25 kg x £7.20) 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 38.40 Less: Material (1.25 kg x £7.20) 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 38.40 Less: Material (1.25 kg x £7.20) 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 38.40 Less: Material (1.25 kg x £7.20) 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   £ Selling price (£38.40 x 10,000 units) 384,000 Less: Material (£9 x 10,000 units) 90,000 Labour (£16.80 x 10,000 units) 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.   £ Units High 64,800 150,000 Low 59,300 128,000 Difference 5,500 22,000 Variable element: Fixed element: £5,500   = £0.25 per unit 22,000 units £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.   £ Units High 121,000 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.   £ Units High 121,000 18,000 Low 94,000 12,000 Difference 27,000 6,000 Variable element: Fixed element: £121,000 – (18,000 x £4.50) = £40,000 £27,000   = £4.50 per unit 6,000 units

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 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 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 (£) = Break-even in units Contribution per unit (£)  

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 = 8,000 units (£38.40 - £25.80)  

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:   8,125 units £ Sales 422,500 Variable costs: Material 87,750 Labour 125,125 Expenses 30,875 Fixed costs: Overheads 143,000 Profit 35,750 Calculate: (a) Contribution per unit (b) Break-even point in units (c) Break-even point in revenue.

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

Target profit Fixed costs (£) + Target profit (£) = units to be sold 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 (£) = units to be sold Contribution per unit (£)  

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   Unit price £ 11,500 units Sales 38.40 441,600 Variable costs: Material 9.00 103,500 Labour 16.80 193,200 Fixed costs: Overheads 100,800 Profit 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 Sales volume to achieve target profit (b) Sales revenue to achieve target profit 7,300 units x £52 = £379,600 £143,000 + £17,600 = 7,300 units £22  

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  

Fixed costs (£) + Target profit (£) 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 (£) = sales revenue to achieve target profit CS ratio  

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 = £441,768 0.328  

Poll Question 2 The following information relates to a single product   8,125 units £ Sales 422,500 Variable costs: Material 87,750 Labour 125,125 Expenses 30,875 Fixed costs: Overheads 143,000 Profit 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   8,125 units £ Sales 422,500 Variable costs: Material 87,750 Labour 125,125 Expenses 30,875 Fixed costs: Overheads 143,000 Profit 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

Budgeted volume – Break-even volume Margin of Safety % Margin of safety is often expressed as a percentage. The formula is: Budgeted volume – Break-even volume x 100 = MOS % Budgeted volume  

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 = MOS % Budgeted volume  

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 %.

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 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.