1. 1 Using the Cigar Box® CB1: Profit calculations made easy by Olivier van Lieshout Global Facts www.globalfacts.nl

2. 2 Contents 1. The five profit parameters 2. Using CB1

3. 3 Part 1 The five profit parameters Learning objectives: 1. There are only five basic parameters. 2. But these have many components. 3. Know the difference between variable and fixed costs.

4. 4 Profit parameters There are ONLY FIVE parameters PPrice (per unit) VCVariable cost (per unit) qQuantity (in units per period) FCFixed cost (per period) TTax % of profit (per period) Note: q, FC, T must always refer to the same period. But…

5. 5 Profit parameters: Price There are ONLY FIVE parameters, but… with many components! Price

6. 6 Profit parameters: VC & FC There are ONLY FIVE parameters but with many components! VC FC Where to obtain correct data ?

7. 7 Profit parameters: quantity There are ONLY FIVE parameters but with many components! q=actual quantity sold per period q CAP =quantity at full capacity utilization quantity/hour * hours/day * days/year (harvest season) 3 ton/hour * 22 hours/day * 90 days/yr = 5940 ton/year q BE =break-even quantity, where profit = 0

8. 8 Recognize costs - exercise 1. Ingredients 2. Road tax 3. Labels 4. Bank charges 5. Machine repair 6. Raw material transport 7. Depreciation 8. Social tax 9. Diesel for the boiler 10. Electricity in the factory 11. Electricity in the office 12. Casual labor 13. Management salary 14. Detergents and gloves 15. Interest on loans 16. Carton boxes Are the following Variable or Fixed costs?

9. 9 Profit parameters (repetition) There are ONLY FIVE parameters PPrice (per unit) VCVariable cost (per unit) qQuantity (in units per period) FCFixed cost (per period) TaxTax % of profit (per period) Not more!

10. 10 Part 2 Using CB1 Learning objectives: to be able to 1. fill in the Cigar Box with five parameters; 2. analyze the results; 3. see the importance of capacity utilization.

11. 11 P VC FC q contribution profit P-VC profit per unit Break-even Capacity Utilization

12. 12 Sales price P Sales Price = Amount per unit, INCO-term City. Tomato paste price = USD 1000 per ton, DDP Moscow. DDP = delivered, duties paid. Delivered to Moscow in this case. The import duties in Russia are 10% or USD 100 per ton. Transport and commission amount to USD 144 per ton. Hence the Price EXW = 1000-100-144 = USD 756 per ton.

13. 13 Variable cost VC Three types of variable cost: VC1, cost of everything which is consumed: raw material and ingredients. VC2, cost of processing raw material into the finished product: energy, steam, casual labor, detergents, diesel, gas. VC3, cost of primary (jar, cap, label) and secondary (carton box, shrink wrap, pallet) packing material.

14. 14 Raw material & ingredients VC1 The price of the raw material, delivered to the factory = 71/ton. The processing ratio is the quantity of raw material needed for one unit of finished good. Here: 6 kg tomato for 1 kg of paste. Raw material cost = 71 * 6 = 429 The higher the losses, the higher the processing ratio, the more costly the good. Calculate the cost of all other ingredients in the recipe: 12 VC1 = 429 + 12 = 441.

15. 15 Processing cost VC2 Calculating VC2 is not easy. Processing cost are calculated per hour. And divided by the production volume in units per hour. To arrive at the processing cost per unit. One must measure the use of steam, electricity, casual labor. Not just guess it! And measure the output per hour. Not just guess it! Get the correct data! After that, calculation is easy: 124 / 2 = 62

16. 16 Packing cost VC3 Packing cost are calculated per sales unit: 1 aseptic bag in 1 steel drum = 3.2 + 18.6 = 21.8; Other examples of sales units: 24 bottles per carton = 24*(bottle + cap + label) + 1 box + 1 sticker; 10 sachets per bag = 10*sachet + 1 bag + 1 adhesive sticker Calculate the number of sales units per unit of calculation: unit of calculation is ton = 1000 kg 4.4 drums of 225 kg per ton: 1000 / 225 = 4.4 add the packing losses, say 2.2%, multiply 4.4 by 102.2% = 4.5 VC3 = cost of packing * number of packs per unit = 21.8 * 4.5 = 99

17. 17 Total variable cost VC VC = VC1 + VC2 + VC3 Finished good losses Warehouse losses, theft, pilferage, etc…. If there are 2% losses, enter 2% in FG losses % box. VC = (VC1 + VC2 + VC3) * (1+ FG losses %) VC = (441 + 62 + 99) * 1.02 = 614

18. 18 Margin P–VC Margin, or gross margin, is expressed per unit: Margin = P(EXW) – VC = 756 – 614 = 142

19. 19 Margin % (P–VC) / P * 100% Margin % = Margin / P(EXW) * 100% = 142 / 756 = 19% Margin % helps us to evaluate, if a margin is risky or not. Usual risk levels in food processing and manufacturing are:

20. 20 Contribution (P–VC) * q The volume, or quantity sold is expressed in units per period. In this example, 3600 ton of tomato based are sold. Contribution is expressed per period: Contribution = Margin per unit * quantity per period = = 142 * 3600 = 511,623

21. 21 Fixed costs Three types of fixed cost: FC1, cost of investments: depreciation. FC2, cost of debts: interest. FC3, cost of all overheads. Salaries, social taxes, pensions, etc.. Repairs, maintenance Office & transport cost Marketing Etc…..

22. 22 Depreciation FC1 Use a realistic value for the productive assets. For a tomato processing company this is about 1.8 million. Use a realistic depreciation rate. Here: the replacement period of the factory is 12.8 years. The depreciation = 1 / 12.8 * 100% = 7.8% FC1 = Asset value * depreciation % = 1,800,000 * 7.8% = 140,000

23. 23 Interest FC2 Use the real amount of the debts, with a minimum of 40% of the asset value. For this company this is about 720,000 Use a realistic interest rate. Here: 18.7% per year. FC2 = Debt value * interest rate = 720,000 * 18.7% = 134,400

24. 24 Overhead FC3 Enter the number of full-time equivalent staff (FTE) 10 workers, working 6 months per year = 10 * 6/12 = 5 FTE 10 workers, working 4 months per year = 10 * 4/12 = Calculate their salaries, incl. all taxes and emoluments: 50,000 Calculate one lump sum amount for all other overheads: 20,000 FC3 = salaries + all other overhead = 50,000 + 20,000 = 70,000 3.3 FTE

25. 25 Total fixed costs FC FC = FC1 + FC2 + FC3 FC = 140,000 + 134,400 + 70,000 = 344,400 The contribution of tomato paste must exceed these costs. In case more than 1 product is produced, FC must be shared. Calculate FC % attributed to product and enter in the box: 100% FC (attributed to product) = FC * FC % attributed to product

26. 26 Profit Two methods Cost accounting method: Profit = Contribution – Fixed costs Bookkeeping method: Profit = Total revenues – Total costs Result is the same!

27. 27 Summary Cost price Cost price = total cost per unit

28. 28 Break-even Break-even point is where the profit is zero. Revenues – Cost = 0 or Contribution – Fixed cost = 0 Why calculating the break-even quantity? When Price, VC and FC are known and q is unknown How many drums can be sold per year? BE volume (sales) = minimum volume needed to sell to make a profit. BE volume (raw material) = minimum volume needed to process. How much raw material do we need to buy?

29. 29 Capacity q = quantity sold = 3,600 tons of paste per year q CAP = quantity produced at full capacity utilization quantity/hour * hours/day * days/year (harvest season) 2 ton/hour * 22 hours/day * 110 days/yr = 4,840 ton/year utilization = q / q CAP * 100% = 3,600 / 4,840 = 74.4%

30. 30 Capacity utilization How does capacity utilization affect the Cost Price? the higher the utilization %, the higher the q (sales). the higher the q, the lower the FC/q, VC does not change, hence the lower the cost price. How does capacity utilization affect the Profit? the higher the capacity utilization, the more the units sold and the lower the cost price, thus the higher the profit per unit. Profit = profit per unit * units sold At 74% utilization: = 46.5 * 3600 = 167,400 At 91% utilization: = 63.8 * 4400 (+22%) = 280,920 (+67%) Conclusion: with 22% increase in sales volume, the profit increases by 67%!!

31. 31 Let’s practice! Each person with own laptop. Sample Cigar Boxes can be downloaded from www.globalfacts.nl www.globalfacts.nl