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.

Costs and Revenues

Selling price – Variable costs = Contribution

Calculating contribution

Contribution is a key element of short-term decision making

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






Labour (1.4 hrs x £12) 16.80







Labour (1.4 hrs x £12) 16.80







Labour (1.4 hrs x £12) 16.80


Total contribution £Selling price (£38.40 x 10,000 units) 384,000

Less: Material (£9 x 10,000 units) 90,000Labour (£16.80 x 10,000 units) 168,000

Total contribution 126,000

£Total contribution 126,000Less: Fixed costs 100,800Total profit 25,200

Or: £12.60 x 10,000 units = £126,000

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.

£5,500 = £0.25 per unit22,000 units

Fixed element:Variable element:

£64,800 – (150,000 x £0.25) = £27,300

£ UnitsHigh 64,800 150,000

Low 59,300 128,000

Difference 5,500 22,000

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.

£ UnitsHigh 121,000 18,000

Low 94,000 12,000


Student Example 1 - Answer

£27,000 = £4.50 per unit6,000 units

Fixed element:Variable element:

£121,000 – (18,000 x £4.50) = £40,000

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.

£ UnitsHigh 121,000 18,000

Low 94,000 12,000


• 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.

Identifying cost behaviour

Calculate the variable cost per unit (to the nearest penny) for the following product:

Poll Question 1

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

Calculate the variable cost per unit (to the nearest penny) for the following product:

Poll Question 1 - Answer

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

Sales revenue > Costs = Profit

Break-even

Sales revenue < Costs = Loss

Break-even point: Sales revenue = Costs

The calculation of break-even uses the total fixed costs and the contribution per unit

Calculating break-even

Fixed costs (£) = Break-even in units

Contribution per unit (£)

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:

Example – Break-even in units

£100,800 = 8,000 units(£38.40 - £25.80)

Break-even is: Units x Selling Price per unit

Break-even in sales revenue

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

The following information relates to a single product:

Student Example 2

8,125 units£

Sales 422,500Variable costs: Material 87,750Labour 125,125Expenses 30,875Fixed costs: Overheads 143,000Profit 35,750

Calculate:(a) Contribution per unit(b) Break-even point in units(c) Break-even point in revenue.

(a) Contribution per unit

Selling price per unit: £422,500 ÷ 8,125 = £52Variable cost per unit: (£87,750 + £125,125 + £30,875) ÷ 8,125 = £30Contribution 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


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

Target profit

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

Contribution per unit (£)

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:

Example – Calculating target profit in units

£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.

The following information relates to a single product:Selling price per unit £52.00Contribution per unit £22.00Fixed overheads £143,000Target profit £17,600

Calculate:(a) Sales volume to achieve target profit(b) Sales revenue to achieve target profit

Student Example 3

(a) 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

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:

Contributions to sales ratio

Contribution per unit (£) = CS ratio

Selling price per unit (£)

Product DTX has a selling price of £38.40 per unit and contribution of £12.60 per unit

The CS ratio is:

Example – Calculating CS Ratio

£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

The sales revenue required break-even is calculated as:

Using the CS Ratio

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

Fixed costs (£) = sales revenue to break-even

CS ratio

Fixed costs (£) + Target profit (£)

= sales revenue to achieve target profit

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:

Example – Using the CS ratio

£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

The following information relates to a single product

Poll Question 2

The CS ratio is:

A. 0.085B. 0.423C. 2.364D. 0.577

8,125 units

£Sales 422,500Variable costs: Material 87,750Labour 125,125Expenses 30,875Fixed costs: Overheads 143,000Profit 35,750

The following information relates to a single product

Poll Question 2 - Answer

The CS ratio is:

A. 0.085B. 0.423C. 2.364D. 0.577

8,125 units

£Sales 422,500Variable costs: Material 87,750Labour 125,125Expenses 30,875Fixed costs: Overheads 143,000Profit 35,750

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

Margin of safety (MOS)

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

Example – Margin of safety

Margin of safety is often expressed as a percentage.

The formula is:

Margin of Safety %

Budgeted volume – Break-even volume

x 100 = MOS %

Budgeted volume

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:

Example – Margin of Safety %

12,000 units – 8,000 units x 100 = 33%

12,000 units

Margin of safety in units x 100 = MOS %

Budgeted volume

The following information relates to a single product:Selling price per unit £52.00Contribution per unit £22.00Fixed overheads £143,000Budgeted 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

(a) Margin of safety in units8,125 units – 6,500 units = 1,625 units

(b) Margin of safety in sales revenue1,625 units x £52 = £84,500

(c) Margin of safety %(1,625 units ÷ 8,125 units) x 100 = 20%


1. Identifying the sales revenue required for a new project to break-even 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.

Making decisions using contribution and break-even

Documents

Costs and Revenues