Budget Analysis of a Manufacturing Company: Break-even Point and Profit-Volume Chart, Schemes and Mind Maps of Applied Computing

Download Budget Analysis of a Manufacturing Company: Break-even Point and Profit-Volume Chart and more Schemes and Mind Maps Applied Computing in PDF only on Docsity! 1 CMA311S – NOTES 2010. UNIT 1: COST-VOLUME-PROFIT ANALYSIS Example 1: Tokio Ltd manufactures and sells only one product. The product is sold at N$10 per unit. Other details are as follows: Variable cost per unit N$5 Fixed cost per month N$20 000 Normal sales per month 6 000 units Required: 1. Calculate the contribution per unit. 2. Calculate the contribution ratio (P/V ratio). 3. Calculate the break-even point in units. 4. Calculate the break-even point in sales value (N$). 5. Calculate the margin of safety and the margin of safety ratio. 6. Draw a break-even graph which clearly indicates the break-even point. 7. Calculate the net profit per month if 5 000 units are sold. 8. Suppose the variable cost increases to N$6 per unit and the fixed cost decreases to N$18 000. 8.1 Calculate how many more units have to be sold in order to break-even. 8.2 Calculate the number of units to be sold in order to earn a net profit of N$7 500 per month. Solution to Example 1 1. Contribution per unit = Selling price per unit – variable cost per unit = N$10 – N$5 = N$5 2. Contribution ratio = Contribution per unit ÷ Selling price per unit = N$5 ÷ N$10 = 0,5 (or 50%) 3. Break-even point (in units) = Fixed cost ÷ Contribution per unit = N$20 000 ÷ N$5 = 4 000 units 4. Break-even point (in sales value) = Fixed cost ÷ Contribution ratio = N$20 000 ÷ 0,5 = N$40 000 OR Break-even point (in sales value) = Break-even units x Selling price per unit = 4 000 x N$10 = N$40 000 5. Margin of safety (in units) = Sales – Break-even sales = 6 000 – 4 000 = 2 000 units OR Margin of safety (in sales value) = Sales – Break-even sales = N$60 000¹ – N$40 000 = N$20 000 ¹ Normal sales = 6 000 units x N$10 Margin of safety ratio = (Margin of safety ÷ Sales) x 100% = (2 000 ÷ 6 000) x 100% 2 = 33,3% OR Margin of safety ratio = (Margin of safety ÷ Sales) x 100% = (N$20 000 ÷ N$60 000) x 100% = 33,3% 6. Graphical presentation of break-even point (break-even graph, break-even chart): Costs and revenue (N$’000) Y Profit area 60 Sales revenue Break-even point Total cost line 40 Margin of Safety Loss area Variable cost 20 Fixed cost 0 1 2 3 4 5 6 X Units of Production and Sales (‘000) 7. Sales revenue (5 000 units x N$10) N$50 000 – Variable cost (5 000 units x N$5) N$25 000 = Contribution N$25 000 – Fixed cost N$20 000 = Net profit (net income) N$ 5 000 8.1 Break-even sales (in units) = Fixed cost ÷ Contribution per unit = N$18 000 ÷ N$4 = 4 500 units New break-even point (4 500 units) less Previous break-even point (4 000 units) = Difference (500 units) Thus: the company will have to sell 500 more units in order to break even. 8.2 If the company sells 4 500 units, the profit is zero (break-even point). However, for every additional unit in excess of 4 500, the profit is N$4. Therefore, in order to show a profit of N$7 500, the company will have to sell an additional 1 875 units per month (N$7 500 ÷ N$4). Contribution chart This is an alternative presentation of the break-even point. In this case the variable cost line is drawn first. The fixed costs are represented by the difference between the total cost line and the variable cost line, with 5 1.3.2 to attract sufficient demand to utilize full capacity would require a 15% reduction in the current selling price and a N$5 000 special advertising campaign. You are required to present a statement showing the effect of the two alternatives compared with the original budget and to advise management which of the three possible plans should be adopted, i.e. the original budget plan or 10.4.1 above or 10.4.2 above. 1.4 An independent market research study shows that by spending N$15 000 on a special advertising campaign, the company could operate at full capacity and maintain the selling price at N$32 per unit. You are required to: 10.4.1 advise management whether this proposal should be adopted; and 10.4.2 state any reservations you might have. Solution to Activity 1 1.1 Variable costs = N$54 000 + N$72 000 + N$18 000 + N$27 000 = N$171 000 Variable cost per unit = N$171 000 ÷ 9 000 units = N$19 per unit Fixed costs = N$42 000 + N$36 000 = N$78 000 Break-even point (in units) = Fixed cost ÷ Contribution per unit = N$78 000 ÷ (N$32 – N$19) = N$78 000 ÷ N$13 = 6 000 units Break-even point (in sales value) = B/E point in units x Selling price per unit = 6 000 x N$32 = N$192 000 1.2 Profit-volume graph 75% Capacity = Sales of N$288 000 (9 000 units) → This was given in the question N$288 000 (9 000 units) 100 Therefore, 100% Capacity = 1 X 75 = N$384 000 (12 000 units) X-axis: Volume (Sales) 0 N$192 000 N$384 000 Y-axis: Net income N$78 000 (Fixed costs) 0 (B/E point) N$ 78 000 6 Y 120 Break-even point At sales of N$192 000 Profit area Profit (N$’000) 80 Loss area 40 0 40 3 000 6 000 9 000 12 000 X Units of Production and Sales Loss (N$’000) 80 Fixed cost = N$78 000 120 Y1 1.3.1 Proposal 1: Total contribution = (90% x 12 000 units x N$9) = N$97 200 Less fixed overheads = N$78 000 Net income = N$19 200 1.3.2 Proposal 2: Total contribution = (12 000 units x N$8,20) = N$98 400 Less fixed overheads = (N$78 000 + N$5 000) = N$83 000 Net income = N$15 400 Recommendation: Based on the above information management should adopt the original budget plan as this yields the largest profit. 1.4.1 Contribution = 12 000 units x N$13 = N$156 000 Less fixed costs (N$78 000 + N$15 000) = N$ 93 000 Net income = N$ 63 000 Recommendation: This proposal yields the largest profit and therefore should be accepted. 1.4.2 However, there is a risk that the estimated sales demand will not be obtained and this could result in a reduced profit since the N$15 000 will be a committed cost irrespective of the outcome. Management would need some assurance that the market research company is reliable and has a good track record. 7 Cost-volume-profit analysis: Multi-products In today’s complex production times no company produces a single product only. In other words, the previous discussions based on a single product were too simplistic. Often companies produce and sell more than one product. Breakeven analysis under these circumstances is somewhat more complex than discussed earlier in this chapter. The reason is that different products will have different selling prices, different costs, and different contribution margins. Consequently the breakeven point will depend on the mix in which the different products are sold. Businesses try to achieve the combination (or mix) that will yield the greatest amount of profits. Most companies produce several products and often these products are not equally profitable. Where this is true, profits will depend to some extent on the company’s sales mix. Profits will be greater if high-margin rather than low-margin items make up a relatively large proportion of total sales. Changes in sales mix can cause interesting variations in a company’s profits. A shift in the sales mix from high margin items to low margin items can cause total profits to decrease even though total sales may increase. Conversely, a shift in the sales mix from low margin items to high margin items can cause total profits to increase even though total sales may decrease. It is one thing to achieve a particular sales volume; it is quite a different thing to sell the most profitable mix of products! Calculation of break-even point in units You will recall from the previous paragraphs above that the break-even point in units is calculated as follows: Total fixed costs Break-even point in units = Contribution per unit When there is more than one product, the formula is adjusted as follows: Total fixed costs Break-even point in units = Average contribution per unit Example 3 Hangana Ltd supplied the following information regarding its three products: Product A Product B Product C Sales in units Selling price per unit Variable cost per unit 2 000 N$20 N$16 3 000 N$50 N$36 5 000 N$40 N$28 Total fixed cost = N$77 000 Required: Compute the company’s break-even point in units. 10 4.2 Required sales = (Fixed costs + Expected profit) ÷ Average contribution per unit = (N$363 000 + N$99 000) ÷ N$6,60 = 70 000 units Individual break-even sales in units: A 70 000 x 0,4 = 28 000 units B 70 000 x 0,3 = 21 000 units C 70 000 x 0,3 = 21 000 units 70 000 units Activity 3 Dynatone Tape Company produces two types of blank recording tapes that it distributes through wholesalers or sells directly to large retailers. The following data apply to these products: Product Sales price Variable costs Contribution Expected % of units sold Cassette N$2,00 N$0,60 N$1,40 60 Cartridge N$3,00 N$1,10 N$1,90 40 Total fixed costs = N$3 000 Required: 3.1 Calculate the break-even point in units and in N$ for each product individually. 3.2 Calculate the number of units and sales value in N$ of each product necessary to achieve a net income of N$600. Calculation of break-even point in sales value In the previous paragraphs above you learned that the break-even point in sales value could be determined in two different ways: Break-even point in sales value = Break-even point in units x Selling price per unit OR Total fixed costs Break-even point in sales value = Contribution ratio In a multi-product situation, the break-even point in sales value can also be calculated in two different ways by adjusting these two formulas. • By using the weighted average selling price per unit One way of calculating the break-even point in sales value is to compute the weighted average selling price per unit and then applying the following formula: Break-even sales value = Break-even quantity x Weighted average selling price per unit Example 5 Refer to Example 3 above. Required: Compute the break-even point in sales value by first computing the weighted average selling price per unit. 11 Solution to Example 5 Product Sales price per unit x Sales mix = Weighted selling price A B C N$20 N$50 N$40 0,20 0,30 0,50 N$ 4 N$15 N$20 Weighted average selling price per unit N$39 Break-even point in sales value = Break-even point in units x Weighted average selling price per unit = 7 000 x N$39 = N$273 000 Activity 4 A company manufactures and sells two products, X and Y. Forecast data for a year are: Product X Product Y Sales (units) 80 000 20 000 Sales price (per unit) N$12 N$8 Variable cost (per unit) N$ 8 N$3 Annual fixed costs are estimated at N$273 000. What is the break-even point in sales revenue with the current sales mix? A N$570 000 B N$606 667 C N$679 467 D N$728 000 (Hint: First calculate the break-even point in units). • By using the average contribution ratio If the average contribution ratio is known, the break-even point in sales value can be computed by means of the following formula: Total fixed costs Break-even point in sales value = Average contribution ratio Example 6 Refer to Example 3 above Required: Calculate the break-even point in sales value by first computing the average contribution ratio. Solution to Example 6 Average contribution per unit Average contribution ratio = Average selling price per unit N$11 = N$39 = N$0,28205 OR 12 Product Units x Sales price = Sales revenue – Variable cost = Contribution A B C 2 000 3 000 5 000 N$20 N$50 N$40 N$ 40 000 N$150 000 N$200 000 N$ 32 000 N$108 000 N$140 000 N$ 8 000 N$ 42 000 N$ 60 000 Totals 10 000 N$390 000 N$280 000 N$110 000 Total contribution Average contribution ratio = Total sales N$110 000 = N$390 000 = 0,28205 Fixed costs Break-even point in sales value = Average contribution ratio N$77 000 = 0,28205 = N$273 000 Activity 5 Refer to Activity 3 above. Repeat the question without first calculating the break-even point in units. Activity 6 H Limited manufactures and sells two products, J and K. Annual sales are expected to be in the ratio of J:1 and K:3. Total annual sales are planned to be N$420 000. Product J has a contribution to sales ratio of 40%, whereas that of product K is 50%. Annual fixed costs are estimated to be N$120 000. The budgeted break-even sales value (to the nearest N$1 000) is: A N$196 000; B N$200 000; C N$253 000; D N$255 000 E Cannot be determined from the above data. Activity 7 Z plc currently sells products Aye, Bee and Cee in equal quantities and at the same selling price per unit. The contribution to sales ratio for product Aye is 40%; for product Bee it is 50% and the total is 48%. If fixed costs are unaffected by mix and are currently 20% of sales, the effect of changing the product mix to: Aye 40%; Bee 25%; Cee 35% is that the total contribution : total sales ratio changes to: A 27,4% B 45,3% C 47,4% D 48,4% E 68,4% Activity 8 PE Limited produces and sells two products, P and E. Budgets prepared for the next six months give the following information: 15 Example 8 Nerina CC supplied the following information regarding their four products for the year 2005: 1. Sales, Variable costs and Contributions: Product A Product B Product C Product D N$ N$ N$ N$ Sales Variable costs Contribution 200 000 205 000 (5 000) 400 000 350 000 50 000 200 000 175 000 25 000 100 000 70 000 30 000 2. Fixed costs: N$50 000 Required: 8.1 Plot the relevant information on a Profit-volume graph (P/V chart) and indicate the break-even sales clearly. 8.2 Check the correctness of your answer by calculating the break-even sales with the aid of an applicable formula. Solution to Example 8 Step 1: Calculation of individual as well as average contribution ratios: Ranking = D, B, C, A. Step 2: Calculation of cumulative sales and cumulative net income: D D + B D + B + C D + B + C + A N$ N$ N$ N$ N$ Sales (X-axis) 0 100 000 500 000 700 000 900 000 Net income (Y-axis) (50 000) (20 000) 30 000 55 000 50 000 Step 3: The profit-volume graph can now be plotted as follows: Product A Product B Product C Product D Total Calculations N$ N$ N$ N$ N$ Sales Less Variable costs = Contribution Less Fixed costs = Net income 200 000 205 000 (5 000) 400 000 350 000 50 000 200 000 175 000 25 000 100 000 70 000 30 000 900 000 800 000 100 000 50 000 50 000 Contribution ratio - 0,025 0,125 0,125 0,30 0,111 16 Y Net income N$’000 80 Profit area 70 60 55  Product A 50  Product C 40 30  20 Product B 10 0 100 200 300 400 500 600 700 800 900 1 000 1 100 1 200 X -10 Volume (sales) units ‘000 -20  Break-even point (N$450 450) -30 Product D Loss area -40 Fixed costs N$50 000 -50 -60 8.2 Break-even sales = Fixed costs ÷ Average contribution ratio = N$50 000 ÷ 0,111 = N$450 450 17 Activity 9 Desert Ltd supplied the following information regarding their three products for the year 2010: 1. Sales, Variable costs and Contribution: Product A Product B Product C N$ N$ N$ Sales 600 000 200 000 500 000 Variable costs 590 000 150 000 460 000 Contribution 10 000 50 000 40 000 2. Fixed costs: N$40 000 Required: 9.1 Plot the relevant information on a Profit-volume graph (P/V chart) and indicate the break-even sales clearly. 9.2 Check the correctness of your answer by calculating the break-even sales with the aid of an applicable formula. Activity 10 Namsa Ltd supplied the following information regarding their three products for the year 2010: 1. Sales, Variable costs and Contribution: Product A Product B Product C N$ N$ N$ Sales 100 000 100 000 600 000 Variable costs 70 000 90 000 560 000 Contribution 30 000 10 000 40 000 2. Fixed costs: N$50 000 Required: 10.1 Plot the relevant information on a Profit graph (P/V chart) and indicate the break-even sales clearly. 10.2 Check the correctness of your answer by calculating the break-even sales with the aid of an applicable formula. Cost structure and the operating leverage factor The concept cost structure refers to the relative relationship between fixed and variable costs in an enterprise. During recent years the cost structure of manufacturing enterprises has changed in that costs have become more fixed as a result of automation. More machines and less manual labour are used in production. Enterprises with a high percentage fixed costs are more sensitive to changes in sales than enterprises with a low percentage fixed costs. For example, consider a firm with relatively high fixed costs (ie, relatively low variable costs and consequently a high profit-volume ratio). If sales should increase, profit will increase as a higher rate than for a firm with relatively low fixed costs, because of the high profit-volume ratio. However, if sales should drop, profit will also drop at a higher rate because, although variable costs will drop as well, the fixed costs (rent, salaries, etc) must still be paid. 20 Activity 12 George Awarab recently opened a shop that specialises in car polish, a product that he has developed himself. He has just received a diploma in accounting and is anxious to apply the principles he has learned at the Polytechnic. As a first step, he has prepared the following analysis for his new store: Sales price per tin N$40 Variable costs per tin 16 Marginal income per tin N$24 Fixed costs per year: Rent on building N$15 000 Depreciation on equipment 7 000 Selling expenses 20 000 Administrative expenses 18 000 Total fixed costs N$60 000 Required: 12.1 Determine how many tins of polish must be sold each year in order to break even. What does this represent in total N$ sales? 12.2 George has decided that he must earn at least N$18 000 during the first year to justify his time and effort. Determine how many tins of polish he must sell to reach this target profit. 12.3 George now has a part-time sales person working in the store. It will cost him an additional N$8 000 per year to convert the part-time position to a full-time post. George believes that the change would bring in an additional N$25 000 in sales each year. Determine whether he should convert the position. Use the incremental approach (do not prepare an income statement). 12.4 Refer to the original data. During the first year, the store sold only 3 000 tins of polish and reported the following operating results: Sales (3 000 tins) N$120 000 Less variable costs 48 000 Marginal income 72 000 Less fixed costs 60 000 Net income N$ 12 000 12.4.1 Determine the store’s degree of operating leverage. 12.4.2 George is confident that with a more intense sales effort and with a more creative advertising program he can increase sales by 50% next year. Determine what the expected percentage increase in net income would be (use the degree of operating leverage to compute your answer). Cost-volume-profit analysis assumptions It is highly unlikely that selling price and variable costs per unit as well as fixed costs in total will remain constant for a given period. Therefore, certain assumptions are part of break-even analysis. These assumptions have given rise to criticism against CVP analysis. However, despite this criticism it remains a useful management tool for short-term decision-making and profit planning. Summary CVP analysis is a useful tool with which to do certain short-term investigations and make decisions. It puts an enterprise in a position to calculate its sales in order to make an expected profit level. It is therefore also useful in evaluating the effect of operating changes on profit. These changes include changes in the selling price and fixed costs. CVP analysis is liable to contain certain simplified assumptions that are necessary to make the analysis clear and understandable. 21 Solution to Activity 2 2.1 Product Contribution x Sales mix Weighted contribution Solvex N$3 0,6 N$1,80 Dysolve N$8 0,4 N$3,20 Weighted average contribution per unit N$5,00 Break-even point = Fixed costs ÷ Average marginal income per unit = N$29 700 ÷ N$5 = 5 940 units 2.2 Product Contribution x Sales mix Weighted contribution Solvex N$3 0,5 N$1,50 Dysolve N$8 0,5 N$4,00 Weighted average contribution per unit N$5,50 Break-even point = Fixed costs ÷ Average marginal income per unit = N$29 700 ÷ N$5,50 = 5 400 units Solution to Activity 3 Product Selling price Variable cost Contribution Sales mix Weighted contribution per unit Cassette N$2 N$0,60 N$1,40 0,6 N$0,84 Cartridge N$3 N$1,10 N$1,90 0,4 N$0,76 Weighted average contribution per unit N$1,60 Break-even point (in units) = Fixed cost ÷ Average contribution per unit = N$3 000 ÷ N$1,60 = 1 875 units Individual break-even sales in units: Cassettes: 1 875 x 0,6 = 1 125 units Cartridges: 1 875 x 0,4 = 750 units 1 875 units Break-even point (in sales value): Cassettes: 1 125 units x N$2 = N$2 250 Cartridges: 750 units x N$3 = N$2 250 Total sales to break even = N$4 500 3.2 Required sales = (Fixed cost + Expected profit) ÷ Average contribution per unit = (N$3 000 + 600) ÷ N$1,60 = 2 250 units Individual break-even sales in units: Cassettes: 2 250 x 0,6 = 1 350 units Cartridges: 2 250 x 0,4 = 900 units 2 250 units 22 Break-even point (in sales value): Cassettes: 1 350 units x N$2 = N$2 700 Cartridges: 900 units x N$3 = N$2 700 Total sales to break even = N$5 400 Solution to Activity 4 Product Contribution per unit x Sales mix = Weighted contribution X Y N$4 N$5 0,80 (80 000 ÷ 100 000) 0,20 (20 000 ÷ 100 000) N$3,20 N$1,00 Weighted average contribution per unit N$4,20 Fixed costs Break-even point in units = Average contribution per unit N$273 000 = N$4,20 = 65 000 units Solution to Activity 5 Product Selling price Variable cost Contribution Sales mix Weighted contribution Cassette N$2 N$0,60 N$1,40 0,6 N$0,84 Cartridge N$3 N$1,10 N$1,90 0,4 N$0,76 Average N$1,60 Break-even point (in units) = Fixed cost ÷ Average marginal income = N$3 000 ÷ N$1,60 = 1 875 units Individual break-even sales in units: Cassettes: 1 875 x 0,6 = 1 125 units Cartridges: 1 875 x 0,4 = 750 units Break-even point (in sales value): Cassettes: 1 125 units x N$2 = N$2 250 Cartridges: 750 units x N$3 = N$2 250 Total sales to break even = N$4 500 5.2 Required sales = (Fixed cost + Expected profit) ÷ Average marginal income = (N$3 000 + 600) ÷ N$1,60 = 2 250 units Individual break-even sales in units: Cassettes: 2 250 x 0,6 = 1 350 units Cartridges: 2 250 x 0,4 = 900 units Break-even point (in sales value): Cassettes: 1 350 units x N$2 = N$2 700 Cartridges: 900 units x N$3 = N$2 700 Total sales to break even = N$5 400 25 Profit-volume graph (P/V chart) Net income N$’000 70 Profit area 60 Product A  50  40 Product B 30 20 10  Product C 0 100 200 300 400 500 600 700 800 900 1 000 1 100 1 200 1 300 -10 Volume (sales) units ‘000 -20 Break-even point (N$500 000) -30 Loss area -40 Fixed costs 9.2 Break-even sales = Fixed costs ÷ Contribution ratio = N$40 000 ÷ 0,08 = N$500 000 Solution to Activity 10 10.1 Calculations: Product A Product B Product C Total N$ N$ N$ N$ Sales 100 000 100 000 600 000 800 000 Variable costs 70 000 90 000 560 000 720 000 Contribution 30 000 10 000 40 000 80 000 Fixed costs 50 000 Net income 30 000 26 Contribution ratio 0,30 0,10 0,067 0,10 A A + B A + B + C N$ N$ N$ N$ Sales 0 100 000 200 000 800 000 Net income (50 000) (20 000) 10 000 30 000 Contribution graph (Profit-volume chart): Profit-volume graph (P/V chart): Net income N$’000 Profit area 30  Product C 20 10  0 100 200 300 400 500 600 700 800 -10 Product B Volume (sales) units ‘000 -20  Break-even point (N$500 000) -30 Product A Loss area -40 -50 Fixed costs 10.2 Break-even sales = Fixed costs ÷ Marginal income ratio = N$50 000 ÷ 0,10 = N$500 000 27 Solution to Activity 11 11.1 Income Statement Amount Percentage Sales revenue N$500 000 100% Less: Variable costs 300 000 60% = Contribution 200 000 40% Less: Fixed costs 150 000 30% = Net income 50 000 10% 11.2 Contribution = 40% of sales revenue = 40% of N$425 000 (N$500 000 less 15%) = N$170 000 Net income = Contribution – Fixed costs = N$170 000 – N%150 000 = N$20 000 Therefore, net income has decreased by 60% (from N$50 000 to N$20 000) 11.3 Operating leverage factor = Contribution ÷ Net profit = N$200 000 ÷ N$50 000 = 4 11.4 % increase in net income = % increase in sales x operating leverage factor = 20% x 4 = 80% Solution to Activity 12 12.1 Break-even point (in units) = Fixed costs ÷ Marginal income per unit = N$60 000 ÷ N$24 = 2 500 tins Break-even point (in N$) = 2 500 x N$40 = N$100 000 12.2 Required sales = (Fixed costs + Target profit) ÷ Marginal income per unit = (N$60 000 + N$18 000) ÷ N$24 = N$78 000 ÷ N$24 = 3 250 tins 12.3 Incremental sales N$25 000. Incremental marginal income = N$15 000 Incremental fixed costs = 8 000 Incremental net income = N$ 7 000 Yes, he should convert this position because he will earn an extra N$7 000. 12.4.1 Operating leverage = Marginal income ÷ Net income = N$72 000 ÷ N$12 000 = 6 12.4.2 Percentage increase in net income = Percentage increase in sales x operating leverage = 50% x 6 = 300%