A and F-Using Accounting Info Tcm4-117030

NATIONAL QUALIFICATIONS CURRICULUM SUPPORT
Accounting and Finance

Using Accounting Information
Break-even Analysis Profit Maximisation Financial Analysis
[INTERMEDIATE 2] Dorothy Brown
IN T RO D UC T IO N
First published 1998 Electronic version 2002 Scottish Consultative Council on the Curriculum 1998 This publication may be reproduced in whole or in part for educational purposes by educational establishments in Scotland provided that no profit accrues at any stage. Acknowledgement Learning and Teaching Scotland gratefully acknowledge this contribution to the National Qualifications support programme for Accounting and Finance. ISBN 1 85955 653 1 Learning and Teaching Scotland Gardyne Road Dundee DD5 1NY www.LTScotland.com
HIST O RY
CONTENTS
Section One Section Two Section Three
Break-even Analysis Profit Maximisation Financial Analysis
1-53 57-94 97-144
AC C OU NT ING AN D FI N AN C E
iv
INTRODUCTION
This publication contains both summary notes and a range of computational exercises covering break-even analysis, profit maximisation and financial analysis. It also includes questions covering the underpinning knowledge and understanding of the unit and suggested solutions to all questions and exercises. At the end of each section, there ar e extension exercises which are designed to stretch more able students and take them in the direction of Higher level. The exercises are not intended to be used for assessment purposes. The publication is targeted at students who are undertaking the High er Still Using Accounting Information Unit at Intermediate 2 level. It covers the basic knowledge required in dealing with break -even analysis, limiting factors for profit maximisation and ratio calculation for financial analysis. Teachers and lecturers are expected to augment these as, where and when they deem it appropriate. For simplicity of use the publication has been divided into three sections: Section One - Break-even Analysis Section Two - Profit Maximisation Section Three - Financial Analysis
vi
AC C OU NT I NG AN D FI N AN C E
Section One
Break-even Analysis
Contents Break-even analysis - summary notes, example, tasks and suggested solutions Break-even charts - summary notes, example, tasks and suggested solutions Exercises 1-6 with suggested solutions Contribution and profit in break-even analysis - summary notes, examples, tasks with suggested solutions Break-even analysis - theory questions with suggested solutions Exercises 1-12 with suggested solutions Extension exercises 1-3 with suggested solutions
1-6
7-9 10-18
19-27 28-30 31-47 48-53
B RE AK -E VE N AN AL Y SIS
SECTION ONE
Break-even point
What is meant by the term break even? A firm breaks even when income is sufficiently high to exactly cover total costs therefore neither a profit nor a loss is made. However, break-even analysis is not usually applied to the whole firm but rather to a single product, studying its profitability by comparing its estimated revenue and costs. Break-even analysis does more than just estimate the break -even point (BEP): it also shows how much profit or loss should be made at various levels of activity. It is therefore seen as a valuable tool for the management accountant. To use break-even analysis several assumptions must be made: there is only one product all costs can be classified as either fixed or variable costs remain constant over the whole range of output selling price remains constant for the whole range of output production is equal to sales so there is no adjustment for stock figures there are no changes in materials, labour, design or manufacturing methods.
Revision point: Fixed costs are those that do not change with changes in production levels, e.g. rent. Variable costs vary in proportion to changes in production levels, e.g. raw materials.
A simple table can be drawn up to show: increasing levels of activity estimated costs of production at these levels estimated revenue at these levels the resulting profit/loss for each level.
B RE AK - E VE N AN A LY SI S
Example 1 The following figures have been supplied by A Gardiner, who is considering making plant pots. He is particularly concerned to know how many he must make before the product becomes profitable. Total fixed costs Variable costs per unit Selling price per unit 1,000 3 8
We can draw up a table to show the information. Units of output 0 100 200 300 400 500 Fixed costs 1,000 1,000 1,000 1,000 1,000 1,000 Variable costs 300 600 900 1,200 1,500 Total costs 1,000 1,300 1,600 1,900 2,200 2,500 Sales revenue 800 1,600 2,400 3,200 4,000 Profit (loss) (1,000) (500) 500 1,000 1,500
At an output of 200 units, where both sales revenue and total costs amount to 1,600, he is making neither a profit nor a loss on the plant pots. Any output below 200 units will result in a loss. Any output above 200 units will result in a profit. Break-even point is therefore at a sales volume of 200 units and a sales revenue of 1,600.
Profit/loss
Profit/loss (the difference between sales revenue and total costs) at various output levels is shown in the final column of the table on p. 2. At 100 units of output the loss is (500) and at 400 units of output a profit of 1,000 is made. Break-even analysis is thus useful in forecasting profit/loss figures for different production levels.
Margin of safety
Output above BEP which gives a profit is the margin of safety. This margin can be measured by comparing the level of output with BEP and it can be expressed in units or in sales revenue. Units of BEP output (units) Margin of safety Selling price (units) per unit 100 200 300 8 8 8 Margin of safety (sales revenue) 800 1,600 2,400
300 400 500
200 200 200
The margin of safety in sales revenue can also be calculated by comparing the sales revenue for the output level with the sales revenue at BEP. Sales revenue 2,400 3,200 4,000 Formulae: Margin of safety (units) = actual units BEP units BEP (sales revenue) 1,600 1,600 1,600 Margin of safety 800 1,600 2,400
Margin of safety (revenue) = actual revenue BEP revenue or actual units BEP units x selling price per unit
Task 1 Use the following information supplied by Julie Carter to complete the table and answer the questions that follow. Total fixed costs Variable costs per unit: materials wages Selling price per unit Units of output Fixed costs Variable costs 12,000
7 5
12 20 Total costs Sales revenue Profit (loss)
0 500 1,000 1,500 2,000 2,500 3,000 (a) (b) What is the break-even point in units and sales revenue? What is the margin of safety (in units and sales revenue) at an output of 2,000 units? How much is the profit when 3,000 units are produced?
(c)
Task 2 Julie is considering reducing the selling price to 18 per unit although the costs would remain unchanged. Draw up another table to show the effect of this change on the figures then answer the following questions. (a) (b) What is the break-even point in units and sales revenue? What is the margin of safety (in units and sales revenue) at an output of 2,500 units? How much is the profit at an output of 2,500 units?
(c)
Suggested solution to Task 1 Units of output Fixed costs 12,000 12,000 12,000 12,000 12,000 12,000 12,000 Variable costs 6,000 12,000 18,000 24,000 30,000 36,000 Total costs 12,000 18,000 24,000 30,000 36,000 42,000 48,000 Sales revenue 10,000 20,000 30,000 40,000 50,000 60,000 Profit (loss) (12,000) (8,000) (4,000) 4,000 8,000 12,000
0 500 1,000 1,500 2,000 2,500 3,000
(a) Break-even point
= 1,500 units or 30,000 sales revenue.
(b) Margin of safety at 2,000 units = 2,000 1,500 = 500 units 500 units x 20 = 10,000 sales revenue (c) Profit at 3,000 units = 12,000
Suggested solution to Task 2 Units of output Fixed costs 12,000 12,000 12,000 12,000 12,000 12,000 12,000 Variable costs 6,000 12,000 18,000 24,000 30,000 36,000 = = Total costs 12,000 18,000 24,000 30,000 36,000 42,000 48,000 Sales revenue 9,000 18,000 27,000 36,000 45,000 54,000 Profit (loss) (12,000) (9,000) (6,000) (3,000) 3,000 6,000
0 500 1,000 1,500 2,000 2,500 3,000 (a) (b)
Break-even point Margin of safety
2,000 units or 36,000 sales revenue 2,500 2,000 units = 500 units 500 units x 20 = 10,000 sales revenue 3,000
(c)
Profit at 2,500 units
Break-even charts
A chart is a simple method of conveying information, particularly where there are many figures to be read. A line chart is considered the most suitable way of showing the data in the previous tables. A break-even chart displays the following details: fixed costs shown as a horizontal line total costs (fixed + variable costs) shown as a straight line sloping upwards from the start of the fixed costs line revenue (sales) an upward sloping line starting from the origin (indicated by 0) of the graph where no output results in no revenue. It has been constructed from the table on page 2, and shows fixed costs, total costs, revenue lines and the BEP.
Break-even point is where the sales revenue and total costs lines cross. The area of profit/loss at any level of output can be measured between the sales revenue and total costs lines: the area of profit, known as the margin of safety, is to the right of breakeven point the area of loss is to the left of break-even point.
Constructing a break-even chart

Before a break-even chart is produced, the following points should be considered: the level of activity is always shown on the horizontal axis and it must allow for all levels of production to be s hown sales revenue and costs (in ) are shown on the vertical axis: the scale chosen should allow for the highest possible figure (usually the highest sales figure) the chart must have a title the axes (vertical and horizontal) must be clearly labell ed a key must be shown to identify each line (or the lines can be labelled) the sales revenue line will always begin at the origin of the graph (no sales = no revenue) the fixed costs line is horizontal (fixed costs do not change with changes in production levels) the total costs line starts at the same point as the fixed costs line the break-even point must be clearly labelled. Task 3 (a) Using graph paper, draw a break-even chart to illustrate the figures in the table for Task 1 (p. 4). Label clearly the fixed costs, total costs and revenue lines and the break-even point. On the same chart, add the new sales revenue line for the figures in Task 2 (p. 5), showing the new break-even point.
(b)
Suggested solution to Task 3(a)
Suggested solution to Task 3(b)
Break-even charts: exercises

Exercise 1 (a) Using the data given below prepare a break-even chart to show fixed costs, total costs, sales and break-even point. Data Total fixed costs Variable costs per unit Selling price per unit Projected output levels (b) 4,000 15 25 100700 units
From your chart find the break-even point in (i) units of output (ii) sales value.
(c)
Find the profit at output levels of 500 and 700 units.
Exercise 2 (a) Using the data given below prepare a break-even chart to show fixed costs, total costs, sales and break-even point. Data Total fixed costs Variable costs per unit Selling price per unit Projected output levels (b) 48,000 12 24 1,0007,000 units
From your chart find the break-even point in (i) units of output (ii) sales value
(c)
Find the profit at outputs of 5,000 and 7,000 units.
10
Exercise 3 (a) Prepare a break-even chart to show fixed costs, total costs and sales revenue lines. Indicate the break-even point. Data Variable costs per unit: materials labour 10 15 40 60,000 1,0008,000 units
Selling price per unit Total fixed costs Projected output levels (b) From your chart find the break-even point in (i) (c) (d) units of output (ii)
sales value
Find the profit expected at outputs of 6,000 and 8,000 units. Management are considering increasing the selling price to 45 per unit. Add this new sales line to your chart and show the new break even point. State the new break-even point in (i) units of output (ii) sales value
(e)
(f)
Find the new profit expected at outputs of 4,000 and 6,000 units.
11
Exercise 4 (a) Using the following information prepare a break-even chart, labelling break-even point. Data Projected output levels Total fixed costs Variable costs per unit: Selling price per unit (b) From your chart find the break-even point in (i) (c) (d) units of output (ii) sales value 1,0007,000 units 40,000 12 10 30
materials wages
Find the profit expected at outputs of 6,000 and 7,000 units. It may be possible to reduce the cost of materials to 10 per unit. Add the new total costs line to your chart and show the new break -even point. State the new break-even point in (i) units of output (ii) sales value
(e)
(f)
Find the new profit expected at outputs 5,000 and 7,000 units.
12
Exercise 5 Study the break-even chart below and answer the questions that follow.
(a) (b) (c)
How much are the fixed costs? What is the total variable cost of making 100 units? What is the total cost of producing (i) 100 units (ii) 300 units? (i) 200 units (ii) 500 units?
(d)
What revenue is received from
(e) (f)
Give the break-even point in units of output and in sales revenu e. Find the profit made at the following levels of output: 500 units, 600 units and 700 units.
13
Exercise 6 Study the break-even chart below and answer the questions that follow.
(a) (b) (c)
How much are the fixed costs? What is the total variable cost of making 300 units? What is the total cost of producing (i) 300 units (ii) 600 units? What revenue is received from (i) 300 units (ii) 600 units? Give the break-even point in units of output and in sales revenue. Find the profit made at the following levels of output: 700 units and 800 units.
(d)
(e) (f)
14
Break-even charts: suggested solutions to exercises

Exercise 1 (a)
(b) (c)
Break-even point Profit at 500 units Profit at 700 units
= 400 units; 10,000 = 1,000 = 3,000
Exercise 2 (a)
(b) (c)
Break-even point
= 4,000 units; 96,000
Profit at 5,000 units = 12,000 Profit at 7,000 units = 36,000
15
Exercise 3 (a)
(b) (c)
Break-even point Profit at 6,000 units Profit at 8,000 units
= 4,000 units; 160,000 = 30,000 = 60,000
(d)
(e) (f)
= 3,000 units; 120,000 = 20,000 = 60,000
16
Exercise 4 (a)
(b) (c)
= 5,000 units; 150,000 = 8,000 = 16,000
(d)
(e) (f)
New break-even point = 4,000 units; 120,000 Profit at 5,000 units Profit at 7,000 units = 10,000 = 30,000
17
Exercise 5 (a) (b) (c) Total fixed costs Variable cost of 100 units Total cost of 100 units Total cost of 300 units Revenue from 200 units Revenue from 500 units Break-even point Profit at 500 units Profit at 600 units Profit at 700 units = 4,000 = 1,000 = 5,000 = 7,000 = 3,600 = 9,000 = 500 units; 9,000 = 0 = 800 = 1,600
(d)
(e) (f)
Exercise 6 (a) (b) (c) Total fixed costs Variable cost of 300 units Total cost of 300 units Total cost of 600 units Revenue from 300 units Revenue from 600 units Break-even point Profit at 700 units Profit at 800 units = 6,000 = 6,000 = 12,000 = 18,000 = 9,000 = 18,000 = 600 units; 18,000 = 1,000 = 2,000
(d)
(e) (f)
18
Contribution in break-even analysis calculation of BEP

Although break-even charts are easily produced and interpreted, it is not necessary to have a chart to find the profitability of a product at different output levels. This can be done by simple calculation. The word contribute is familiar in its usual meaning of give or donate. In break-even analysis the word contribution is used for the amount which the sale of each unit gives towards meeting the fixed costs. In other words, the amount left over after meeting the variable costs can be put towards the fixed costs. Once the fixed costs have been covered, that contribution becomes profit. Example Lightwell makes lamps and is investigating the profitability of producing a new design. The following figures are available. Estimated variable cost per lamp 40 Selling price per lamp 60 Total fixed costs 4,000 (a) How much is the contribution per lamp? Contribution per lamp = selling price variable costs = 60 40 = 20 (b) If each lamp can contribute 20 towards meeting the fixed costs, how many lamps need to be sold in order to break even? Break-even point (BEP) = fixed costs unit contribution 4,000 20
= 200 lamps (c) What is the sales revenue of these lamps? BEP in sales revenue = selling price number of lamps = 60 200 lamps = 12,000
19
Check: Sales revenue of 200 units Less variable cost of 200 units Total contribution from 200 units Fixed costs = 60 200 = 40 200 = 12,000 8,000 = 12,000 = 8,000 = = 4,000 4,000
At break-even point, total contribution equals total fixed costs.
Formulae: BEP (units) BEP (revenue) = fixed costs/unit contribution = fixed costs/unit contribution x selling price per unit
20
Task 4 Complete the figures in the following table. Firm Selling price Variable cost Contribution per unit per unit per unit a b c d e 30 5 8 140 380 15 3 7 90 260 Fixed BEP BEP costs (units) (revenue) 15,000 5,000 4,000 50,000 240,000
21
Suggested solution to Task 4 Firm Selling price Variable cost Contribution per unit per unit per unit a b c d e 30 5 8 140 380 15 3 7 90 260 15 2 1 50 Fixed BEP BEP costs (units) (revenue) 15,000 5,000 4,000 50,000 1,000 2,500 4,000 1,000 30,000 12,500 32,000 140,000
80 240,000
3,000 1,140,000
22
Contribution in break-even analysis calculation of profit

Break-even analysis can be used to estimate profit or loss at various levels of output. On a break-even chart, the margin of safety is the area to the right of break-even point where output is greater than break -even point and a profit is shown. The margin of safety is the excess of sales over break -even point and can be expressed in sales volume (units) and sales revenue (). At break-even point fixed costs have been covered therefore in the margin of safety contribution becomes profit. The calculation of profit is therefore very simple. In the Lightwell example on p. 19, break -even point is 200 units therefore all output above 200 units results in profit. The table below shows how much profit will be made at output levels of 250, 320, 400, 480 and 550 units. Output level (units) 250 320 400 480 550 BEP (units) Margin of safety (units) 50 120 200 280 350 Contribution per unit 20 20 20 20 20 Profit 1,000 2,400 4,000 5,600 7,000
200 200 200 200 200
Check: Output level (units) 250 320 400 480 550 Unit contribution 20 20 20 20 20 Total contribution 5,000 6,400 8,000 9,600 11,000 Fixed costs 4,000 4,000 4,000 4,000 4,000 Profit 1,000 2,400 4,000 5,600 7,000
23
Contribution in break-even analysis calculation of required output

As well as being used to forecast profit or loss at different levels of output, break-even analysis is also useful in calculating the output required to give a certain amount of profit. After break-even point, contribution becomes profit therefore: total contribution required = fixed costs + desired profit. Example M Morrison has provided the following information: Selling price per unit Variable costs per unit Contribution per unit Total fixed costs (a) 30 20 10 2,000
What is the total contribution required to give a profit of 1,000? Total contribution required = fixed costs + profit = 2,000 + 1,000 = 3,000 How many units will give this total contribution? Total contribution required = 3,000 Unit contribution = 10 Output required = 3,000 10 = 300 units
(b)
24
Check: Break-even point = 2,000 10 200 units 1,000 10 1,000 10 100 units break-even point + profitable units 200 + 100 units 300 units
= Profit required Unit contribution Number of profitable units = = =
= Total output required = = =
25
Task 5 Complete the figures in the following table using the information in the example on p. 24. Profit required 1,000 1,800 2,300 3,000 3,500 Fixed costs 2,000 2,000 Total contribution 3,000 Unit contribution 10 10 10 Required output (units) 300
Check: Required profit 1,000 1,800 2,300 3,000 3,500 Unit contribution 10 10 10 Profitable output (units) 100 180 Break-even point (units) 200 200 200 Required output (units) 300
26
Suggested solution to Task 5 Profit required 1,000 1,800 2,300 3,000 3,500 Fixed costs 2,000 2,000 2,000 2,000 2,000 Total contribution 3,000 3,800 4,300 5,000 5,500 Unit contribution 10 10 10 10 10 Required output (units) 300 380 430 500 550
Check: Required profit 1,000 1,800 2,300 3,000 3,500 Unit contribution 10 10 10 10 10 Profitable output (units) 100 180 230 300 350 Break-even point (units) 200 200 200 200 200 Required output (units) 300 380 430 500 550
27
Break-even analysis: theory questions

Question 1 Break-even analysis is seen as a valuable tool for the management accountant. List 3 of its uses.
Question 2 List 4 assumptions made in the use of break-even analysis.
Question 3 Explain what is meant by the following terms used in break -even analysis: (a) (b) (c) (d) unit contribution margin of safety break-even point fixed and variable costs.
Question 4 Describe how each of the following lines can be shown on a break -even chart: (a) (b) (c) fixed costs total costs sales.
Question 5 After break-even point, contribution becomes profit. Explain what is meant by this statement.
28
Break-even analysis: suggested solutions to theory questions

Question 1 Three uses of break-even analysis are: 1 to calculate the break-even point in units of output and in sales revenue for a product to estimate the profit/loss that will result from any given level of output to find the level of output needed for a given profit figure.
2 3
Question 2 Four assumptions made in the use of break-even analysis are: 1 2 all costs are either fixed or variable the selling price remains unchanged for the entire range of output regardless of different markets and conditions costs remain unchanged because there are no changes in materials, wages or methods there is no adjustment for stock figures because production is equal to sales.
Question 3 (a) Unit contribution is the difference between the selling price and the variable costs of one unit. It is the amount the unit can give towards meeting the fixed costs and, after fixed costs are covered, towards profit. Margin of safety is the profitable output above break -even point and can be expressed in units or sales revenue. It is shown to the right of break-even point on a break-even chart. Break-even point is the point at which fixed costs are covered and neither a profit nor a loss is made. Total contribution is equa l to fixed costs and total revenue is equal to total costs. Fixed costs remain unchanged regardless of changes in the level of production. Variable costs vary in proportion to changes in production levels.
(b)
(c)
(d)
29
Question 4 (a) The fixed costs line is horizontal because fixed costs remain constant at different output levels. The total costs line slopes upward to the right from the start of the fixed costs line. The sales line slopes upward to the right from the origin of the graph where no sales shows no revenue.
(b)
(c)
Question 5 Contribution is the difference between selling price and variable costs and, in the first place, goes towards meeting fixed costs. Once fixed costs have been covered, i.e. at break-even point, any further contribution that arises from additional sales is profit as only the variable costs have to be met.
30
Contribution in break-even analysis: exercises

Exercise 1 Three firms have supplied the following information: A Anderson Variable costs per unit Selling price per unit Fixed costs (a) (b) (c) 3.00 6.00 4,500 B Benson 4.50 8.50 6,400 C Cameron 6.80 11.80 17,500
Calculate the contribution per unit for each firm. For each firm find the break-even point in units of output. For each firm find the sales revenue at break-even point.
Exercise 2 A manufacturing firm expects to sell 8,000 units in the next year and has provided the following figures: Selling price per unit Variable costs per unit Total fixed costs (a) (b) (c) (d) 40 22 63,000
Calculate the contribution per unit. Find the break-even point in units of output. What is the sales revenue of these units? What is the margin of safety in (i) units (ii) sales revenue ()?
31
Exercise 3 Alert plc installs burglar alarm systems and expects to in stall 400 units of System A in the next year. Costs are estimated as follows: Total fixed costs Selling price per unit Variable costs per unit (a) (b) (c) (d) 81,400 850 480
Calculate the contribution per unit. Find the break-even point in units. Find the sales revenue of these units. What is the margin of safety in (i) units (ii) sales revenue ()?
Exercise 4 The following data has been supplied by D Denver, who is considering manufacturing a new style of shirt: Selling price per unit Variable costs per unit: materials wages Total fixed costs (a) (b) (c) (d) (e) 21.00 6.50 4.50 33,000
Calculate the contribution per shirt. Find the break-even point in units of output. What is the sales revenue of these units? What is the new contribution per shirt if they could be sold at 22 each? Calculate the new break-even point in units at the increased selling price. What is the sales revenue of these units?
(f)
32
Exercise 5 Novelties plc assembles novel clocks and has estimated the fo llowing figures for a new style: Selling price per unit Variable costs per unit: component parts wages Total fixed costs (a) (b) (c) (d) 34 12 6 8,960
Calculate the contribution per clock. Find the break-even point in units of output. Find the sales revenue of these units. If the cost of the component parts is increased to 14, what is the new contribution per unit? Find the new break-even point in units and in sales revenue.
(e)
Exercise 6 Downies plc makes quilts and has budgeted the following figures for an output of 20,000 units: Total fixed costs Selling price per unit Variable costs per unit (a) (b) (c) (d) 198,400 85 54
Calculate the contribution per quilt. Find the break-even point in (i) units and (ii) sales revenue. What is the margin of safety in (i) units and (ii) sales revenue? If fixed costs were decreased to 179,800 what would be the new break even point in (i) units and (ii) sales revenue?
33
Exercise 7 J Jones has supplied the following figures: Variable costs per unit: materials wages expenses Selling price per unit Total fixed costs (a) (b) (c) (d)
36 15 3 78 60,000
How much is the contribution per unit? Find the break-even point in units. What would be the sales revenue of these units? Calculate the profit at output levels of 3,000 and 4,000 units.
Exercise 8 Outdoor Relaxing plc produces loungers and hopes to sell 1,000 in the coming year. The following figures are forecast: Selling price per unit Variable costs per unit Total fixed costs (a) (b) (c) 52 28 13,920
Calculate the contribution per unit. Find the break-even point in (i) units and (ii) sales revenue. Calculate the profit at output levels of 640 and 720 units.
34
Exercise 9 Deeside Woodworkers produces clocks and the follow ing figures are available: Selling price per unit Variable costs per unit Total fixed costs (a) (b) (c) 80 55 12,000
Calculate the contribution per clock. Find the break-even point in units and in sales revenue. Calculate the profit achieved at the following output levels: 500 and 600 units. If the selling price is increased to 85 while costs remain the same, what is the new contribution per clock? Find the new break-even point in units and in sales revenue.
(d)
(e)
Exercise 10 A leather company produces briefcases and has provided the following data: Total fixed costs Variable costs per unit: materials fastenings and locks wages Selling price per unit 19,800
30 12 25 139
You are required to find the following: (a) (b) (c) (d) contribution per unit break-even point in units and in sales revenue profit at output levels of 300 and 400 units the output level required to give a profit of 7,920.
35
Exercise 11 The following figures relate to ornamental trees supplied by nurserymen J & M Dawson, who have fixed costs of 6,480: Selling price per tree Variable costs per tree (a) (b) (c) 36 20
Find the contribution per unit. Find the break-even point in units and in sales revenue. How many trees would need to be sold in order to achi eve the following profit levels: 1,360 and 5,040? How much is the profit at output levels of 450 and 580 units?
(d)
Exercise 12 Soundsleep plc produces beds which sell at 580 each. The following details of costs have been supplied: Variable costs per unit: materials component parts wages Total fixed costs (a) (b) (c)
80 120 100 686,000
Find the contribution per unit. Find the break-even point in units and in sales revenue. How many beds would need to be sold in order to achieve the foll owing profit levels: 16,800 and 64,400? How much is the profit at output of 5,000 units?
(d)
36
Contribution in break-even analysis: suggested solutions to exercises

Exercise 1 A Anderson (a) Selling price per unit Variable costs per unit Contribution per unit BEP =
fixed costs unit contributi on
B Benson 8.50 4.50 4.00

6,400 4
C Cameron 11.80 6.80 5.00

7,500 5
6.00 3.00 3.00

4,500 3
(b)
= 1,500 units (c) Sales revenue 1,500 6 = 9,000
= 1,600 units
= 3,500 units
1,600 8.50 3,500 11.80 = 13,600 = 41,300
Exercise 2 (a) Contribution per unit = selling price variable costs = 40 22 = 18
(b)
Break-even point
63,000 18
= 3,500 units (c) Sales revenue = 40 3,500 units = 140,000 = sales break-even point = 8,000 3,500 units = 4,500 units = 40 4,500 units = 180,000
(d)
Margin of safety (i)
(ii)
37
(b)
Break-even point
81,400 370
= 220 units (c) Sales revenue = 850 220 units = 187,000 = sales break-even point = 400 220 units = 180 units = 850 180 units = 153,000
(d)
Margin of safety (i)
(ii)
38
Exercise 4 (a) Contribution per shirt = selling price variable costs = 21 11 = 10
(b)
Break-even point
33,000 10
= 3,300 units (c) Sales revenue = 21 3,300 units = 69,300
(d)
Contribution per shirt = 22 11 = 11 Break-even point =

33,000 11
(e)
= 3,000 units (f) Sales revenue = 22 3,000 units = 66,000
39
(b)
Break-even point
8,960 16
= 560 units (c) Sales revenue = 34 560 units = 19,040 = 34 20 = 14

8,960 14
(d)
New contribution
(e)
New break-even point =
= 640 units Sales revenue = 34 640 = 21,760
40
Exercise 6 (a) Contribution per quilt = selling price variable costs = 85 54 = 31
(b)
Break-even point
(i)
198,400 31
= 6,400 units (ii) = 85 6,400 quilts = 544,000 = 20,000 6,400 units = 13,600 units = 85 13,600 units = 1,156,000 =
179,800 31
(c)
Margin of safety
(i)
(ii)
(d)
New break-even point (i)
= 5,800 units (ii) = 85 5,800 = 493,000
41
(b)
Break-even point
60,000 24
= 2,500 units (c) Sales revenue = 78 2,500 units = 195,000 BEP (units) Margin of safety (units) 500 1,500 Profit
(d)
Output level (units) 3,000 4,000
2,500 2,500
500 24 = 12,000 1,500 24 = 36,000
42
Exercise 8 (a) Contribution per unit = selling price variable costs = 52 28 = 24 (i) =
(b)
Break-even point
13,920 24
= 580 units (ii) = 52 580 units = 30,160 Margin of safety (units) 60 140 Profit
(c)
Output level (units) 640 720
BEP (units)
580 580
24 60 = 1,440 24 140 = 3,360
43
Exercise 9 (a) Contribution per clock = 80 55 = 25
(b)
Break-even point
12,000 25
= 480 clocks Sales revenue = 80 480 = 38,400 BEP (units) Margin of safety (units) 20 120 = 85 55 = 30 =
12,000 30
(c)
Profit
480 480
20 25 =
500
120 25 = 3,000
(d)
New contribution
(e)
New break-even point
= 400 units Sales revenue = 85 400 = 34,000
44
(b)
Break-even point
19,800 72
= 275 units Sales revenue = 139 275 units = 38,225 BEP (units) Margin of safety (units) 25 125 Profit
(c)
275 275
72 25 = 1,800 72 125 = 9,000
(d)
Total contribution required = fixed costs + profit = 19,800 + 7,920 = 27,720 Unit contribution = 72
Output required
totalcontributi on unit contributi on
27,720 72
= 385 units
45
(b)
Break-even point
6,480 16
= 405 units Sales revenue = 36 405 units = 14,580 Output required
(c)
Fixed costs
Profit Total Unit required contribution contribution required 1,360 7,840 16
6,480
7,840 = 490 units 16
6,480
5,040
11,520
16
11,520 = 720 units 16
(d)
BEP (units)
Margin of safety (units) 45 175
Profit
405 405
16 45 = 720 16 175 = 2,800
46
(b)
Break-even point
686,000 280
= 2,450 units Sales revenue = 580 2,450 units = 1,421,000 Output required
(c)
Fixed Profit Total Unit costs required contribution contribution required 16,800 702,800 280
686,000
702,800 = 2,510 units 280
686,000
64,400
750,400
280
750,400 = 2,680 units 280
(d)
Output level (units) 5,000
BEP (units)
Margin of safety (units) 550
Profit
2,450
280 550 = 154,000
47
Contribution in break-even analysis: extension exercises

Exercise E1 Wondersew produces sewing machines that are sold at 1,200 each. The following costs are incurred. Fixed costs Variable costs: materials component parts wages 157,500
80 350 140
You are required to calculate the following: (a) (b) (c) (d) (e) (f) (g) the the the the the the the contribution per sewing machine break-even point in units and sales revenue profit at output levels of 320 and 425 units output level required to give a profit of 75,600 new contribution per unit if the selling price is reduced to 1,095 break-even point at the new selling price new output level required to give the same profit of 75 ,600.
Exercise E2 Scotstoun Display Stands estimates that it can sell 2,000 display stands at 200 each. The costs of production are shown below. Variable costs per unit: materials labour 96,000 80 40
Total fixed costs You are required to find: (a) (b) (c) (d)
the break-even point in units and in sales revenue the profit at the following levels of production: 1,400 units and 2,000 units the new break-even point if the selling price is increased by 10% the new profit at output levels of 1,400 a nd 2,000 units.
48
Exercise E3 Stonehaven Clocks makes alarm clocks and has supplied the following figures. Output Total fixed costs Selling price per clock Variable costs per clock: materials component parts labour 6,000 clocks 60,000 37 6 4 12
You are required to calculate the following: (a) (b) the break-even point in units and sales revenue the present profit figure.
Stonehaven Clocks is considering increasing output to 8,000 clocks and estimates that the cost of materials per unit will be r educed to 5. Calculate: (c) (d) the new break-even point in units and sales revenue the new profit figure.
49
Contribution in break-even analysis: suggested solutions to extension exercises

Exercise E1 (a) Contribution per unit = selling price variable costs = 1,200 570 = 630 =
(b)
Break-even point
157,500 630
= 250 units Sales value = 1,200 250 units = 300,000 BEP (units) Margin of safety (units) 70 175 Profit
(c)
250 250
630 70 =44,100 630 175= 110,250
(d)
Total contribution required = fixed costs + required profit = 157,500 + 75,600 = 233,100 Unit contribution Output required = 630
totalcontributi on unit contributi on 233,100 = 630
= 370 units (e) New contribution = 1,095 570 = 525 =

157,500 525
(f)
= 300 units
50
(g)
Total contribution required = 233,100 Unit contribution = 525 Output required =

233,100 525
= 444 units
51
Exercise E2 (a) Unit contribution = 200 120 = 80

Break-even point =
96,000 80
= 1,200 units Sales revenue = 1,200 200 = 240,000
(b)
Profit = (output BEP) x unit contribution Output 1,400 units 1,400 1,200 200 80 16,000 2,000 units 2,000 1,200 800 80 64,000 = 220 = 220 120 = 100 =
96,000 100
(c)
New selling price New contribution
= 960 units New sales revenue = 960 220 = 211,200
(d)
New profit Output 1,400 units 1,400 960 440 100 44,000 2,000 units 2,000 960 1,040 100 104,000
52
Exercise E3 (a) Unit contribution = 37 22 = 15 =

Break-even point
60,000 15
= 4,000 units Sales revenue = 4,000 37 = 148,000 = = = = (6,000 BEP) 15 (6,000 4,000) 15 2,000 15 30,000
(b)
Profit
(c)
New variable costs New contribution
= 21 = 37 21 = 16 =
60,000 16
= 3,750 units Sales revenue = 3,750 37 = 138,750 = = = = (8,000 BEP) 16 (8,000 3,750) 16 4,250 16 68,000
(d)
New profit
53
54
Section Two
Profit Maximisation
Contents Profit maximisation limiting factor, summary note, tasks, suggested solutions Exercises 1-12 with suggested solutions Extension exercises 1-3 with suggested solutions
57-64 65-88 89-94
PRO F I T M AX IM IS A TI O N
SECTION TWO
Profit maximisation: limiting fact or
Most businesses are set up with a view to making a profit, preferably as high a profit as possible. Maximising profit simply means making as much profit as possible from the resources available. This is usually achieved by making as much as can be sold if demand for a product is limited there is no point in making more even though it may be possible to do so. Sometimes demand for a product may be high but production may be limited by factors such as: scarcity of materials scarcity of labour limited machine capacity limited number of machines limited space.
These factors are called limiting factors (or key factors). If a limiting factor exists, management will have to decide which level of output will make most profit, taking into account the limiting factor. Instead of studying the contribution per unit, contribution must be considered in the light of the limiting factor. Example Two products, A and B, are being produced and details are as follows: A Contribution per unit Number of labour hours per unit Number of units demanded Total labour hours available Total fixed costs 12 4 10,000 60,000 hours 160,000 B 12 2 12,000
57
If demand is to be satisfied the total number of labour hours required would be: Product A 10,000 4 40,000 Product B + 12,000 2 + 24,000 = 64,000 hours
The number of labour hours required is 64,000 but only 60,000 labour hours are available. Since there is a shortage of 4,000 hours, labour is the limiting factor. How will this problem be solved? Should one or both products be cut back? B has a lower unit contribution than A so should only B be reduced? Before a decision is taken, the contribution per labour hour must be examined. A Contribution per unit Number of labour hours Contribution per labour hour 12 4 3 B 12 2 6
Only now can the order of priority be decided. Since the product giving the highest contribution per labour hour is B, the full demand for B will be met and the production of A will be cut by 4,000 hours. Production will be planned thus: 1 Product B 2 Product A 24,000 hours/2 60,000 24,000 hours = 36,000 hours/4 = 12,000 units = 9,000 units
How much profit will be made? A Number of labour hours Contribution per labour hour Total contribution 36,000 3 3 36,000 108,000 B 24,000 6 6 24,000 144,000 Total 60,000
252,000 160,000 92,000
Less fixed costs Profit (maximised)
58
Task 6 Skye Weavers plc produces 2 items, rugs and scarves. Figures available are as follows: Total labour hours available Total fixed costs Product Selling price per unit Variable costs per unit Labour hours per unit Number of units demanded 20,000 200,000 Rugs 80 40 2 5,000 Scarves 20 8 1 12,000
Use the accompanying worksheet to carry out the following tasks: (a) Compare the hours available with the hours required to find the shortage of labour hours. What is the limiting factor for Skye Weavers plc? Calculate the contribution per labour hour for each product. Show the order of priority for production. Give a reason for your answer. Show how many labour hours would be used in the production of both rugs and scarves. Find the total contribution from rugs and scarves. Subtract the total fixed costs to find the profit from production. How many scarves and rugs would be made in the hours in (e)?
(b) (c) (d)
(e)
(f) (g) (h)
59
Task 6: worksheet Rugs (a) Units demanded Labour hours per unit Total labour hours required Labour hours available Shortage of labour hours (b) 5,000 .......... .......... Scarves 12,000 .......... .......... .......... .......... .......... Total
The limiting factor is ...........................................................................
(c)
Contribution per unit Labour hours per unit Contribution per labour hour
........ .......... ........
........ .......... ........
(d)
Order of priority:
first second
Reason .................................................................................................
............................................................................................................. (e) Labour hours available for production .......... .......... 20,000
(f)
Contribution per labour hour (from (c) above) Total contribution
........ ........
........ ........ ........ ........ ........
(g)
Total fixed costs Profit
(h)
Scarves and rugs made
..........
..........
60
Suggested solution to task 6 Rugs (a) Units demanded Labour hours per unit Total labour hours required Labour hours available Shortage of labour hours (b) (c) The limiting factor is labour hours Contribution per unit Labour hours per unit Contribution per labour hour (d) Order of priority: first: second: rugs scarves 40 2 20 12 1 12 5,000 2 10,000 Scarves 12,000 1 12,000 22,000 20,000 2,000 Total
Reason Rugs have higher contribution per labour hour, which is the limiting factor. The demand for rugs must therefore be met if possible. (e) (f) Labour hours available for production Contribution per labour hour (from (c) above) Total contribution (g) Total fixed costs Profit (h) Scarves and rugs made 5,000 10,000 10,000 10,000 20,000
20
12
200,000 120,000 320,000 200,000 120,000
61
Task 7 Islay Woodcarvers plc makes 3 products, X, Y and Z, and has provided the following information: Total machine hours available Total fixed costs Product Selling price per unit Variable cost per unit Number of machine hours per unit Number of units demanded 22,000 140,000 X 26 16 1 4,000 Y 48 32 2 6,000 Z 58 40 1.5 5,000
Use the accompanying worksheet to carry out the following tasks: (a) Compare the hours available with the hours required to find the shortage of machine hours. What is the limiting factor for Islay Woodcarvers plc? Calculate the contribution per machine hour for each product. Show the order of priority for production. Give a reason for your answer. Show how many machine hours would be used in the production of each of the 3 products. Find the total contribution. Find the total profit. How many of each product would be made in the hours in (e)?
(b) (c) (d)
(e)
(f) (g) (h)
62
Task 7: worksheet X (a) Units demanded Machine hours per unit Total machine hours required Machine hours available Shortage of machine hours (b) (c) Y Z Total
.......... .......... .......... .......... .......... .......... .......... .......... .......... .......... .......... ..........
The limiting factor is ................................................................ Contribution per unit Machine hours per unit ........ ........ ........ .......... .......... ..........
Contribution per machine hour ........ ........ ........ (d) Order of priority: first: second: Reason ..................................................................................... ................................................................................................. (e) Machine hours available for production
.......... .......... .......... ..........
(f)
Contribution per machine hour ........ ........ ........ Total contribution ........ ........ ........ ........ ........ ........ .......... .......... ..........
(g)
Less total fixed costs Profit
(h)
Number of units made
63
Suggested solution to task 7 X (a) Units demanded Machine hours per unit Total machine hours required Machine hours available Shortage of machine hours (b) (c) The limiting factor is machine hours Contribution per unit Machine hours per unit Contribution per machine hour (d) Order of priority: first: Z 10 1 10 16 2 8 18 1.5 12 4,000 1 4,000 Y 6,000 2 Z 5,000 1.5 23,500 22,000 1,500 Total
12,000 7,500
second: X third: Y
Reason: Highest contribution per machine hour must take priority, followed by second highest if profit is to be maximised because machine hours are the limiting factor. (e) Machine hours available for production Contribution per machine hour Total contribution (g) Less total fixed costs Profit (h) Number of units made 4,000 5,250 5,000
4,000 10
10,500 7,500 8 12
22,000
(f)
40,000 84,000 90,000 214,000 140,000 74,000
64
Limiting factor: exercises

Exercise 1 The total number of labour hours available in AB Components is 20,000. The firm has provided the following additional figures for products X and Y: X (Per unit) Contribution Labour hours Units demanded 4 2 5,000 Y 6 2 7,000
You are required to find the following: (a) (b) (c) (d) (e) the labour hours required to meet current demand the contribution per labour hour for each product the order of priority for production the labour hours available for each product the number of units of each product that can be made.
65
Exercise 2 The total number of labour hours available in Qu ality Doors plc is 5,500. The firm has provided the following additional figures for 2 designs, Georgian and Victorian: Georgian (Per unit) Selling price Variable costs Labour hours Units demanded 150 60 1.5 2,000 Victorian 200 100 2 1,500
You are required to find the following: (a) (b) (c) (d) (e) (f) the labour hours required to meet current demand the contribution per unit for each product the contribution per labour hour for each product the order of priority for production the labour hours available for each product the number of units of each product that can be made.
66
Exercise 3 City Shirts plc produces 3 designs Classic, City and Casual for which 18,000 machine hours are available. The following figures have been provided: Classic (Per unit) Selling price Variable cost Machine hours Units demanded 28 13 0.5 10,000 City 30 16 0.5 12,000 Casual 22 10 0.5 16,000
You are required to find the following: (a) (b) (c) (d) (e) (f) the machine hours required to meet current demand the contribution per unit for each product the contribution per machine hour for each product the order of priority for production the machine hours available for each style the number of units of each style that can be made.
67
Exercise 4 County Suits plc produces 3 designs Kelso, Selkirk and Melrose for which 2,200 machine hours are available. The following figures have been provided: Kelso (Per unit) Selling price Variable cost Machine hours Units demanded 360 180 5 200 Selkirk 280 140 3.5 300 Melrose 250 100 3 180
You are required to find the following: (a) (b) (c) (d) (e) (f) the machine hours required to meet current demand the contribution per unit for each product the contribution per machine hour for each product the order of priority for production the machine hours available for each style the number of units of each style that can be made.
68
Exercise 5 Scottish Greenhouses plc makes 2 products Dunkeld and Aberfeldy. Total fixed costs are 400,000 and 5,000 labour hou rs are available. The following figures are available: Dunkeld (Per unit) Selling price Variable costs Labour hours Units demanded You are required to find the following: (a) (b) (c) (d) (e) (f) (g) (h) the labour hours required to meet current demand the contribution per unit for each product the contribution per labour hour for each product the order of priority for production the labour hours available for each style the number of units of each style that can be made the total contribution the profit after deduction of fixed costs. 1,200 600 5 400 Aberfeldy 800 360 4 800
69
Exercise 6 Rockers Ltd makes 2 styles of chair Relax and Relax-plus for which 1,800 machine hours are available. Total fixed costs amount to 30,000. The following additional information has been provided: Relax (Per unit) Selling price Variable costs Machine hours Units demanded 130 70 1.5 800 Relax-plus 150 90 2 400
You are required to find the following: (a) (b) (c) (d) (e) (f) (g) (h) the machine hours required to meet current demand the contribution per unit for each product the contribution per machine hour for each product the order of priority for production the machine hours available for each style the number of units of each style that can be ma de the total contribution the profit after deduction of fixed costs.
70
Exercise 7 Caledonian Souvenirs produces 3 quality souvenirs, Moray, Dornoch and Beauly. They are all hand-made and a total of 8,000 labour hours is available. Total fixed costs amount to 180,000. Sales demand for the products is expected to be: Moray Dornoch Beauly 2,000 units 1,600 units 1,000 units.
The following figures are also available: Moray (Per unit) Selling price Variable costs Labour hours 120 60 2 Dornoch 200 110 1.5 Beauly 150 80 2
You are required to find the following: (a) (b) (c) (d) (e) (f) (g) (h) the labour hours required to meet current demand the contribution per unit for each product the contribution per labour hour for each product the order of priority for production the labour hours available for each style the number of units of each style that can be made the total contribution the profit after deduction of fixed costs.
71
Exercise 8 West Coast Models plc has a labour supply with a limit of 2,020 hours available. It produces 3 different model boats Class 1, Class 2 and Class 3 and its fixed costs amount to 8,000. The following figures have also been supplied: Class 1 (Per unit) Selling price Variable cost Labour hours Units demanded 480 300 20 20 Class 2 420 240 18 40 Class 3 320 200 15 80
72
Exercise 9 Troon Models, which has a total of 7,000 machine hours available, produces 3 items, coded A, B and C. Total fixed costs are 90,000. The following figures have been supplied: A (Per unit) Selling price Variable cost Machine hours Units demanded 12 8 0.25 6,000 B 30 15 0.5 8,000 C 24 12 0.5 4,000
You are required to find the following: (a) (b) (c) (d) (e) (f) (g) (h) the machine hours required to meet current demand the contribution per unit for each product the contribution per machine hour for each produc t the order of priority for production the machine hours available for each style the number of units of each style that can be made the total contribution the profit after deduction of fixed costs.
73
Exercise 10 The expected demand for the toys made by Terry & Son is as follows: Model 100: Model 200: Model 300: 2,000 units 5,000 units 4,000 units
Two machines are available, each with a capacity limited to 3,000 hours per year. Total fixed costs amount to 70,000. The following figures have also been supplied: Model 100 (Per unit) Selling price Variable cost Machine hours 25 15 0.5 Model 200 20 12 0.25 Model 300 42 26 1
You are required to find the following: (a) (b) (c) (d) (e) (f) (g) (h) the machine hours required to meet current demand the contribution per unit for each product the contribution per machine hour for each product the order of priority for production the machine hours available for each style the number of units of each style that can be made the total contribution the profit after deduction of fixed costs.
74
Exercise 11 The following information has been supplied by Davidson & Williams: total fixed costs: 40,000 labour hours available: 6,500 Product (Per unit) Selling price Variable cost Labour hours Units demanded A B C D
40 20 2 1,000
10 6 0.5 3,000
18 12 1 2,200
8 3 0.25 4,800
75
Exercise 12 Conservatory Decor makes 4 styles of candleholder single, 2-candle, 3-candle and 5-candle and it has a total of 1,400 machine hours available. Fixed costs amount to 14,000. The following additional figures have been supplied: Single (Per unit) Machine hours Variable cost Selling price Units demanded 0.25 8 15 1,600 2-candle 0.25 13 18 600 3-candle 0.5 15 26 1,400 5-candle 0.5 18 30 500
You are required to find the following: (a) (b) (c) (d) (e) (f) (g) (h) the machine hours required to meet current demand the contribution per unit for each product the contribution per machine hour for each product the order of priority for production the machine hours available for each style the number of units of each style that can be made the total contribution the profit after deduction of fixed costs.
76
Limiting factor: suggested solutions to exercises

Exercise 1 X (a) Labour hours required Y Total
2 hours 5,000 2 hours 7,000 10,000 hours 14,000 hours 24,000 hours 4 2
4 2
(b)
Contribution per unit Labour hours per unit Contribution per labour hour
6 2
6 2
2 (c)
First: Y (highest contribution per labour hour) Second: X Labour hours available 6,000 hours 14,000 hours (20,000 14,000) 20,000 hours
(d)
(e)
Units produced
6,000hours 2 hours
14,000hours 2 hours
3,000 units
7,000 units
77
Exercise 2 Georgian (a) Victorian Total
Labour hours required 1.5 hours 2,000 2 hours 1,500 3,000 hours 3,000 hours 6,000 hours Contribution per unit (selling price variable costs) Contribution per labour hour 150 60 90 90 1.5 hours 60 200 100 100 100 2 hours 50
(b)
(c)
(d)
First: Georgian (highest contribution per labour hour) Second: Victorian Labour hours available Units produced 3,000 2,500 (5,500 3,000) 2,500 hours 2 hours 1,250 units 5,500
(e)
(f)
3,000 hours 1.5 hours 2,000 units
78
AC C OU NT I NG AN D FI N ANC E
Exercise 3 Classic (a) Machine hours required Contribution per unit City Casual Total
0.5 10,000 0.5 12,000 0.5 16,000 5,000 hours 6,000 hours 8,000 hours 19,000 hours 28 13 15 30 16 14 14 0.5 28 22 10 12 12 0.5 24
(b)
(c)
Contribution 15 per machine hour 0.5 30 First: Classic Second: City Third: Casual Machine hours available Units produced 5,000 hours
(d)
(e)
6,000 hours
7,000 hours 18,000 hours (18,000 11,000) 7,000 0.5
(f)
5,000 0.5
6,000 0.5
10,000 units 12,000 units 14,000 units
79
Exercise 4 Kelso (a) Machine hours required Contribution per unit Contribution per machine hour Selkirk Melrose Total
5 hours 200 3.5 hours 300 3 hours 180 1,000 hours 1,050 hours 540 hours 2,590 hours 360 180 180 180 5 36 280 140 140 140 3.5 40 250 100 150 150 3 50
(b)
(c)
(d)
First: Melrose Second: Selkirk Third: Kelso Machine hours available Units produced 610 hours 1,050 hours (2,200 1,590) 610 5 122 units 1,050 3.5 300 units 540 hours 2,200 hours
(e)
(f)
540 3 180 units
80
Exercise 5 Dunkeld (a) Labour hours required Contribution per unit Contribution per labour hour 5 hours 400 2,000 hours 1,200 600 600 600 5 120 Aberfeldy 4 hours 800 3,200 hours 800 360 440 440 4 110 Total
5,200 hours
(b)
(c)
(d)
First: Dunkeld Second: Aberfeldy Labour hours available Units produced 2,000 3,000 5,000 (5,000 2,000) 3,000 4 750 units 110 3,000 110 3,000 330,000
(e)
(f)
2,000 5 400 units
(g)
Contribution per labour hour 120 Labour hours 2,000 Total contribution 120 2,000 240,000 Fixed costs Profit
570,000 400,000 170,000
(h)
81
Exercise 6 Relax (a) Machine hours required Relax-plus Total
1.5 hours x 800 2 hours x 400 1,200 hours 800 hours 130 70 60 60 1.5 40 150 90 60 60 2 30
2,000 hours
(b)
Contribution per unit Contribution per machine hour
(c)
(d)
First: Relax Second: Relax-plus Machine hours available Units produced 1,200 600 1,800 (1,800 1,200) 600 2 300 units
(e)
(f)
1,200 1.5 800 units
(g)
Contribution per machine hour Machine hours Total contribution Fixed costs Profit
40 1,200 48,000
30 600 18,000
64,000 30,000 34,000
(h)
82
Exercise 7 Moray (a) Labour hours required (b) Contribution per unit (c) Contribution per labour hour 2 hours 2,000 4,000 hours 120 60 60 60 2 30 Dornoch Beauly Total
1.5 hours 1,600 2 hours 1,000 2,400 hours 2,000 hours 200 110 90 90 1.5 60 150 80 70 70 2 35
8,400 hours
(d) First: Second: Third:
Dornoch Beauly Moray 3,600 hours (8,000 4,400) 3,600 2 1,800 units 2,400 hours 2,000 hours 8,000 hours
(e) Labour hours available (f) Units produced
2,400 1.5 1,600 units 60 x 2,400 144,000
2,000 2 1,000 units 35 x 2,000 70,000
(g) Total contribution 30 x 3,600 108,000 (h) Fixed costs Profit
322,000 180,000 142,000
83
Exercise 8 Class 1 (a) Labour hours required Contribution per unit Contribution per labour hour Class 2 Class 3 15 hours 80 1,200 hours 320 200 120 120 15 8 Total
20 hours 20 18 hours 40 400 hours 720 hours 480 300 180 180 20 9 420 240 180 180 18 10
2,320 hours
(b)
(c)
(d)
First: Class 2 Second Class 1 Third: Class 3 Labour hours available Units produced 400 hours 720 hours 900 hours (2,020 1,120) 900 15 60 units 8 900 7,200 2,020 hours
(e)
(f)
400 20 20 units 9 400 3,600
720 18 40 units 10 720 7,200
(g)
Total contribution
18,000 8,000 10,000
(h)
Fixed costs Profit
84
Exercise 9 A (a) Machine hours required Contribution per unit Contribution per machine hour B C Total
0.25 hours 6,000 0.5 hours 8,000 0.5 hours 4,000 1,500 hours 4,000 hours 2,000 hours 7,500 hours 12 8 4 4 0.25 16 30 15 15 15 0.5 30 24 12 12 12 0.5 24
(b)
(c)
(d)
First: B Second: C Third: A Machine hours available Units produced 1,000 hours (7,000 6,000) 1,000 0.25 4,000 units 4,000 hours 2,000 hours 7,000 hours
(e)
(f)
4,000 0.5 8,000 units 30 4,000 120,000
2,000 0.5 4,000 units 24 2,000 48,000
(g)
Total contribution
16 1,000 16,000
184,000 90,000 94,000
(h)
Fixed costs Profit
85
Exercise 10 Model 100 (a) Machine hours required Contribution per unit Contribution per machine hour 0.5 2,000 1,000 hours 25 15 10 10 0.5 20 Model 200 Model 300 Total
0.25 5,000 1 4,000 1,250 hours 4,000 hours 20 12 8 8 0.25 32 42 26 16 16 1 16
6,250 hours
(b)
(c)
(d)
First: Model 200 Second: Model 100 Third: Model 300 Machine hours available Units produced 1,000 hours 1,250 hours 3,750 hours 6,000 hours (6,000 2,250) 3,750 1 3,750 units 16 3,750 60,000
(e)
(f)
1,000 0.5 2,000 units
1,250 0.25 5,000 units 32 1,250 40,000
(g)
Total contribution
20 1,000 20,000
120,000 70,000 50,000
(h)
Fixed costs Profit
86
Exercise 11 A (a) Labour hours required Contribution per unit Contribution per labour hour 2 1,000 2,000 hours 40 20 20 20 2 10 B 0.5 3,000 1,500 hours 10 6 4 4 0.5 8 C 1 2,200 2,200 hours 18 12 6 6 1 6 D Total
0.25 4,800 1,200 hours 6,900 hours 8 3 5 5 0.25 20
(b)
(c)
(d)
First: Second: Third: Fourth:
D A B C 2,000 hours 1,500 hours 1,800 hours 1,200 hours (6,500 4,700) 1,800 1 hour 1,800 units 6 1,800 10,800 1,200 0.25 hours 4,800 units 20 1,200 24,000 6,500 hours
(e)
Labour hours available Units produced
(f)
2,000 2 hours 1,000 units
1,500 0.5 hours 3,000 units 8 1,500 12,000
(g)
Total contribution
10 2,000 20,000
66,800 40,000 26,800
(h)
Fixed costs Profit
AC C OU NT ING A N D FI N ANC E
87
Exercise 12 Single (a) Machine hours required Contribution per unit Contribution per machine hour 2-candle 3-candle 0.5 1,400 700 hours 26 15 11 11 0.5 22 5-candle 0.5 500 250 hours 30 18 12 12 0.5 24 Total
0.25 1,600 0.25 600 400 hours 150 hours 15 8 7 7 0.25 28 18 13 5 5 0.25 20
1,500 hours
(b)
(c)
(d)
First: Second: Third: Fourth:
Single 5-candle 3-candle 2-candle 400 hours 50 hours 700 hours (1,400 1,350) 250 hours 1,400 hours
(e)
Machine hours available
(f)
Units produced
400 0.25 1,600 units
50 0.25 200 units 20 50 1,000
700 0.5 1,400 units 22 700 15,400
250 0.5 500 units 24 250 6,000
(g)
Total contribution
28 400 11,200
33,600
(h)
Fixed costs Profit
14,000 19,600
88
Limiting factor: extension ex ercises

Exercise E1 Forth Valley Products uses machines that are equally suitable for making any of its products. There is a total machining capacity of 22,000 hours and total fixed costs are 360,000. Sales demand for its 4 products is expected to be as follows: J: K: L: M: 18,000 16,000 20,000 10,000 units units units units.
The following additional data is also given: Product Selling price (per unit) 24 18 25 20 Variable costs (per unit) 18 10 13 12 Machine hours (per unit) 0.25 0.25 0.5 0.5
J K L M
Using the above information, you are required to carry out the following tasks. (a) (b) Calculate the contribution per unit of the limiting factor. Decide which product(s), if any, should be cut back. Give a reason for your choice. Calculate how many machine hours are necessary to satisfy current demand. Calculate how many machine hours will be used for making each of the 4 products in order to maximise profit. Calculate the total contribution and the final profit from this output. How many units of each product will be made? Find the sales revenue of these units.
(c)
(d)
(e) (f) (g)
89
Exercise E2 Main & Morrison plc have a limited labour force that provides 4,200 labour hours per year. Four products are made in the factor y, which has fixed costs of 70,000. Maximum demand for the 4 products is expected to be as follows: A: 200 B: 150 C: 400 D: 320 units units units units.
Budgeted figures for the 4 products have been supplied. Product Variable costs (per unit) 160 110 225 175 Selling price (per unit) 300 230 350 295 Labour hours (per unit) 4 3 5 4
A B C D
Answer each of the following questions. (a) How many labour hours are necessary to meet current demand? Why is it essential to calculate this figure? Can current demand be met with existing resources? If current demand cannot be met, state which product(s) should be cut back, showing calculations to support your answer. Calculate the number of labour hours available for each prod uct. Calculate the number of units that will be produced. Calculate the maximum contribution and profit obtainable from this level of output. What is the sales revenue of the units produced?
(b) (c)
(d) (e) (f)
(g)
90
Exercise E3 Crieff Wood Products plc produces 4 styles of garden seat de Luxe Double, Standard Double, de Luxe Single and Standard Single for which demand is expected to be 200, 500, 100 and 150 units, respectively. The number of labour hours available is 3,300 and fixed costs total 50,000. The following figures are available. Product Selling price (per unit) 250 182 180 130 Materials cost (per unit) 40 30 28 25 Wages cost (per unit) 70 48 56 36 Labour hours (per unit) 5 4 4 3
de Luxe Double Standard Double de Luxe Single Standard Single
Answer each of the following questions. (a) The limiting factor is labour. Explain what is meant by the limiting factor. Calculate the labour hours needed to satisfy current demand. Compare your answer with the number of hours avail able and calculate the shortage of hours. Find the contribution per unit and the contribution per labour hour for each style. Calculate the labour hours to be spent on each style in order to maximise profit. Calculate the total contribution and maximum profit from your suggested output. Calculate the total sales revenue of the output.
(b)
(c)
(d)
(e)
(f)
91
Suggested solutions to extension exercises

Exercise E1 J 24 18 6 6 0.25 24 K 18 10 8 8 0.25 32 L 25 13 12 12 0.5 24 M 20 12 8 8 0.5 16 Total
(a)
Contribution per unit Contribution per machine hour
(b)
Product M should be cut back because it has the lowest contribution per labour hour. Machine hours are scarce (only 22,000 are available) therefore the products given priority are those with the highest contribution per unit of the limiting factor. Machine hours required Machine hours available Total contribution Less fixed costs Profit Units produced 0.25 18,000 4,500 hours 4,500 hours 0.25 16,000 4,000 hours 4,000 hours 0.5 20,000 10,000 hours 10,000 hours 0.5 10,000 5,000 hours 3,500 hours (22,000 18,500) 16 3,500 56,000
(c)
23,500 hours 22,000 hours
(d)
(e)
24 4,500 108,000
32 4,000 128,000
24 10,000 240,000
532,000 360,000 172,000
(f)
4,500 0.25 18,000 units
4,000 0.25 16,000 units 18 16,000 288,000
10,000 0.5 20,000 units 25 20,000 500,000
3,500 0.5 7,000 units 20 7,000 140,000
(g)
Sales revenue
24 18,000 432,000
1,360,000
92
Exercise E2 A (a) Labour hours required 4 hours 200 800 hours B 3 hours 150 450 hours C 5 hours 400 2,000 hours D 4 hours 320 1,280 hours Total
4,530 hours
This figure must be calculated when labour is in scarce supply. It will tell the firm w hether or not there are enough labour hours to fully meet current demand. If not, a level of output will have to be fixed to maximise profit within the limitations. (b) (c) No. Only 4,200 hours are available but 4,530 are required to meet current demand. Contribution per unit Contribution per labour hour 300 160 140 140 4 35 230 110 120 120 3 40 350 225 125 125 5 25 295 175 120 120 4 30
Product C should be cut back because it has the lowest contribution per labour hour. (d) Labour hours available Units produced 800 hours 450 hours 1,670 hours (4,300 2,530) 1,670 5 334 units 25 1,670 41,750 1,280 hours 4,200 hours
(e)
800 4 200 units
450 3 150 units 40 450 18,000
1,280 4 320 units 30 1,280 38,400
(f)
Total contribution Less fixed costs Profit Sales revenue
35 800 28,000
126,150 70,000 56,150
(g)
300 200 60,000
230 150 34,500
350 334 116,900
295 320 94,400
305,800
93
Exercise E3 (a) The limiting factor is a resource that is in short supply, e.g. labour. This means that production has to be planned so that the highest possible profit will be made from the existing labour supply. Output levels will be such that those products whic h give the highest contribution per labour hour will be given priority. de Luxe Double Labour hours required Labour hours available Shortage (c) Contribution per unit Contribution per labour hour 5 hours 200 1,000 hours Standard Double 4 hours 500 2,000 hours de Luxe Single 4 hours 100 400 hours Standard Single 3 hours 150 450 hours Total
(b)
3, 850 hours 3,300 hours 550 hours
250 110 140 140 5 28 1,000 hours
182 78 104 104 4 26 2,000 hours
180 84 96 96 4 24 300 hours (3,300 3,000) 24 300 7,200
130 61 69 69 3 23 3,300 hours
(d)
Labour hours available Total contribution Less fixed costs Profit Units produced Sales revenue
(e)
28 1,000 28,000
26 2,000 52,000
87,200 50,000 37,200
(f)
200 units 250 200 50,000
500 units 182 500 91,000
75 units 180 75 13,500
154,500
94
Section Three
Financial Analysis
Contents Summary note and example Exercises 1-16 with suggested solutions Extension exercises 1-3 with suggested solutions 97-103 104-131 132-144
FI NA NC IA L AN A LY S I S
SECTION THREE
Ratios and percentages

At the end of each financial year Final Accounts are prepared that show the firms profitability and its financial position at that date. These accounts are a record of the firms performance and, by themselves, have limited use since they give no indication of whether the results are favourable or unfavourable. For example, they show the profit/loss figure but there is nothing to i ndicate whether that figure is satisfactory for the firm concerned. The assets are listed in the Balance Sheet but, again, there is nothing to show that they are being used effectively for example, is a bank balance of 10,000 a healthy sign and is an overdraft of 5,000 unhealthy? Management needs to know whether or not: (i) performance is satisfactory (ii) performance is showing improvement on previous years (iii) there are problem areas that should be investigated. It may also be desirable to compare figures with those of competitors or with the average for the industry. A straightforward comparison of figures is usually unhelpful. A profit of 20,000 may be acceptable for one firm but entirely unacceptable for another: if it is related to the capital employed it becomes more meaningful. A return of 20,000 on capital of 100,000 (20%) is obviously better than a return of 20,000 on capital of 200,000 (10%). Ratios and percentages are therefore normally used for the purpose of comparison. Parties who would be interested in the firms ratios are: owners/shareholders who want to see how profitable their investment is potential creditors such as suppliers and banks who would be interested to know if the firm is credit worthy staff who are interested in wage rates, bonuses and profit -sharing, which must be considered in the light of profitability companies interested in take-over bids who want to see profitability and efficient use of assets. The main types of ratio are those relating to profitability and liquidity.
97
Profitability
Profitability ratios show how successful a firm is in relation to capital and sales revenue. Example 1 Year 1 Capital at start Add net profit 20,000 4,000 24,000 2,000 22,000 Year 2 22,000 5,500 27,500 3,000 24,500
Less drawings Capital at end
Return on capital employed =
net profit opening capital
100 1
Return on capital employed
Year 1 4,000 20,000 = 20% 100 1
Year 2 5,500 22,000 = 25% 100 1
This ratio shows there has been adequate return on investment. In the second year profit has increased and the improved ratio indicates that assets have been more effectively employed. This may be due to factors such as economic purchasing procedures, increased advertisi ng and reduced expenses.
98
Example 2 Year 1 Sales Less cost of goods sold Gross profit Less expenses Net profit 60,000 40,000 20,000 8,000 12,000 Year 2 80,000 50,000 30,000 12,000 18,000
Gross profit % =
gross profit sales
100 1
Gross profit %
Year 1 20,000 60,000 = 33.3% 100 1
Year 2 30,000 80,000 = 37.5% 100 1
Gross profit arises from buying and selling stock and the gross profit % shows how much of every 100 of sales is profitable. It is possible for sales volume to increase without a corresponding increase in profitability. In Year 2 there has been an increase in profitability. This may have arisen from buying stock at a lower price because of influences such as a change of buying policy or a change in market prices. On the other hand, it may be the result of selling at an increased price without any increase in costs.
99
Net profit % =
= net profit Sales
100 1
Net profit %
Year 1 12,000 60,000 = 20% 100 1
Year 2 18,000 80,000 = 22.5% 100 1 Year 2 100 1 12,000 80,000 = 15% 100 1 100 1
Expenses % =
= total expenses sales Year 1 8,000 60,000 = 13.3%
Expenses %
The net profit % and the expenses % are linked because net profit is the result of deducting expenses from gross profit. The improvement in gross profit ratio is reflected to some extent in the net profit % but there has been an increase in expenses. There may have been an increase in advertising costs, wages or other running costs and these would be examined to see if they can be reduced.
100
Liquidity
Liquidity ratios show whether the firm can meet its liabilities when they are due. Generally, current assets should cover current liabilities. Potential creditors and lenders will not support a firm wh ose current liabilities are greater than its current assets and the firm may be forced to close because it is bankrupt. Working capital finances the day -to-day trading and if a firm tries to boost sales to a level beyond its capacity, working capital is r educed. This is called overtrading and is a common reason for insolvency. Example 3 Year 1 Current assets: stock debtors bank 2,000 2,500 1,500 6,000 Year 2 5,000 5,000
10,000
Current liabilities: creditors bank
3,000
8,000 3,000 11,000
3,000
Current ratio
current assets current liabilities
Current ratio
Year 1 6,000 3,000 = 2:1
Year 2 10,000 11,000 = 0.9:1
The current ratio has fallen in Year 2 and the firm is now unable to meet the debts that are due within the next few months. This may be because the increased stock level has been financed by borrowing from the bank or because increased credit sales mean a higher debtors figure.
101
Example 4 Year 1 Total credit sales Average debtors Debtors collection period 60,000 2,000 Year 2 75,000 4,000
= debtors 365 days sales Year 1 Year 2
Debtors collection period
2,000 4,000 365 365 60,000 75,000 = 12 days = 19 days
The debtors collection period is how long on average it has taken debtors to pay for their goods. In Year 2 they have been allowed 7 days longer than in Year 1 therefore credit control policy may need to be investigated. It may be that sales were only increased by allowing longer credit to customers. Example 5 Year 1 Total credit purchases Average creditors Creditors payment period 50,000 3,000 = creditors purchases Year 1 3,000 365 50,000 = 21 days Year 2 60,000 2,500 365 Year 2 2,500 365 60,000 = 15 days
Creditors payment period
This ratio shows how long the firm is taking on average to pay for its credit purchases. In Year 2 the time has been shortened by 6 days which means that creditors have tightened their credit terms. It is also possible that the firm is not making full use of the credit facilities available to it and is paying too quickly.
102
Example 6 Year 1 Stock at start Add purchases Goods available Less stock at end Cost of goods sold 14,000 40,000 54,000 12,000 42,000 Year 2 12,000 49,000 61,000 10,000 51,000
Rate of stock turnover
= cost of goods sold average stock Year 1 42,000 13,000 = 3.2 times Year 2 51,000 11,000 = 4.6 times
The rate of stock turnover gives the number of times stock has been changed during the year. The stock figure used is the average of the stock figures available the opening and closing stocks divided by 2. A firm with a fast-moving stock (for example a bakery) will have a very high rate of stock turnover while one with a slow-moving stock (for example a furniture supplier) will have a low figure. In Year 2 the rate of stock turnover has increased because a lower amount of stock is being held while output has risen. Further investigation would show if this trend was favourable and has led to higher pr ofits.
103
Financial analysis: exercises

Exercise 1 From the following information calculate the return on capital employed for each year. Year 1 Capital at start Add profit 50,000 5,000 55,000 1,000 54,000 Year 2 54,000 8,100 62,100 2,100 60,000 Year 3 60,000 15,000 75,000 1,500 73,500
Exercise 2 Copy and complete the following table. Calculate the return on capital employed for each year. Year 1 Capital at start Add profit 100,000 25,000 125,000 5,000 Year 2 Year 3
24,000
21,000
4,000 155,000
104
Exercise 3 Use the information below to calculate the following for each year: (a) (b) (c) gross profit % net profit % expenses %. Year 1 Sales Less cost of goods sold Gross profit Less expenses Net profit 60,000 40,000 20,000 8,000 12,000 Year 2 72,000 54,000 18,000 7,200 10,800 Year 3 96,000 67,200 28,800 9,600 19,200
Exercise 4 Copy and complete the following table then calculate gro ss profit %, net profit %, expenses % and rate of stock turnover. Year 1 Sales Less cost of goods sold Gross profit Less expenses Net profit 120,000 90,000 32,000 18,000 Year 2 160,000 Year 3 220,000 132,000
8,000 66,000
105
Exercise 5 Trading and Profit and Loss Accounts for year ended 31 March Year 1 Sales Less cost of sales Stock at start Add purchases Year 2
80,000
94,000
6,000 50,000 56,000 8,000
8,000 69,800 77,800 12,000
Less stock at end Gross profit Less expenses Net profit
48,000 32,000 16,000 16,000
65,800 28,200 11,280 16,920
Calculate the following ratios for each year: (a) (b) (c) (d) gross profit % net profit % expenses % rate of stock turnover.
106
Exercise 6 Trading and Profit and Loss Accounts for year ended 31 July Year 1 000s Sales Less cost of sales Stock at start Add purchases Year 2 000s
000s 120
000s 140
8 70 78 6
6 74 80 10
Less stock at end Gross profit Less expenses Net profit
72 48 18 30
70 70 28 42
Calculate the following ratios for each year and give one possible reason for any increase/decrease in Year 2: (a) (b) (c) (d) gross profit % net profit % expenses % rate of stock turnover
Exercise 7 Using the following information, calculate the debtors collection period and the creditors payment period for each of the 3 firms. Black Credit purchases Credit sales Average creditors Average debtors 100,000 150,000 10,000 12,000 White 48,000 75,000 2,400 3,500 Gray 235,000 342,500 14,500 13,200
107
Exercise 8 Use the following figures to calculate the debtors collection period and the creditors payment period for each year and comment on any increase/decrease in the ratios in Year 2. Year 1 Credit sales Credit purchases Average debtors Average creditors 88,500 54,200 4,600 2,600 Year 2 96,800 68,800 7,200 2,500
Exercise 9 From the following Balance Sheet extracts calculate the current ratio for each year and suggest a reason for any differences that have arisen. Balance Sheet as at 28 February Year 1 CURRENT ASSETS Stock Debtors Bank Year 2 Year 3
4,000 2,500 4,000 10,500
3,000 1,600 1,400 6,000
4,000 1,400
5,400
CURRENT LIABILITIES Creditors 3,500 Bank 3,500
3,000
3,200 4,000 7,200
3,000
108
Exercise 10 Study the ratios given for Years 1 and 2 then give one possible reason for each of the differences that have arisen. Year 1 (a) (b) (c) (d) (e) Return on capital employed Gross profit % Net profit % Current ratio Debtors collection period 18% 30% 20% 2:1 25 days Year 2 18.5% 40% 22% 2.5:1 32 days
109
Exercise 11 Study the following set of final accounts provided by D Matthews and calculate the ratios listed below. (a) (b) (c) (d) (e) (f) (g) (h) Gross profit % Net profit % Expenses % Return on capital employed Rate of stock turnover Current ratio Debtors collection period Creditors payment period
Trading and Profit and Loss Accounts for year ended 31 December Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit 48,000
2,000 36,800 38,800 2,800
36,000 12,000 4,800 7,200
110
Exercise 11 (contd) Balance Sheet as at 31 December FIXED ASSETS Machinery Delivery van CURRENT ASSETS Stock Debtors Bank Cash LESS CURRENT LIABILITIES Creditors NET CURRENT ASSETS TOTAL ASSETS FINANCED BY Capital at start Add net profit 12,000 7,200 19,200 12,200 3,800
16,000
2,800 2,000 1,000 200
6,000
2,800 3,200 19,200
111
Exercise 12 You have been given the final accounts of A S Wilson and the following figures and for the average firm in this type of business: (a) (b) (c) (d) (e) gross profit % net profit % return on capital employed rate of stock turnover current ratio 27% 9.5% 16% 8 times 2:1
From the final accounts prepare ratios similar to those above and in each case give one possible reason for the difference (if any) between A S Wilsons figures and those of the average firm. Trading and Profit and Loss Accounts for year ended 3 0 June Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit 40,000
4,000 32,000 36,000 6,000
30,000 10,000 6,000 4,000
112
Exercise 12 (contd) Balance Sheet as at 30 June FIXED ASSETS Machinery Delivery van CURRENT ASSETS Stock Debtors LESS CURRENT LIABILITIES Creditors Bank NET CURRENT ASSETS TOTAL ASSETS FINANCED BY Capital at start Add net profit 30,000 4,000 34,000 20,000 12,000
32,000
6,000 8,000
14,000
10,000 2,000
12,000 2,000 34,000
113
Exercise 13 (a) From the information below calculate the following figures: (i) (ii) (iii) (iv) (v) (vi) gross profit % net profit % current ratio debtors collection period creditors payment period rate of stock turnover
Trading and Profit and Loss Accounts for year ended 30 September 000s Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit 000s 60
4 40 44 8
36 24 12 12
114
Exercise 13 (contd) Balance Sheet as at 30 September 000s FIXED ASSETS Motor lorry Machinery CURRENT ASSETS Stock Debtors LESS CURRENT LIABILITIES Creditors Bank TOTAL ASSETS 000s 36 10 000s
46
8 6
14
8 2
10 4 50
FINANCED BY Capital at start Add net profit 40 12 52 2 50
Less drawings
(b)
Compare your answers with the figures given below for the average business in this line and give one possible reason for each differen ce shown. (i) (ii) (iii) (iv) (v) (vi) Gross profit % Net profit % Current ratio Debtors collection period Creditors payment period Rate of stock turnover 40% 25% 1.5:1 30 days 90 days 7 times
115
Exercise 14 The following final accounts have been supplied by Western Builders plc. You are required to calculate the following ratios for both years and comment on any difference: (a) (b) (c) (d) (e) gross profit % net profit % return on capital employed debtors collection period current ratio.
Trading and Profit and Loss Accounts for year ended 31 December Year 1 000s Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit 000s 300 Year 2 000s 000s 400
30 200 230 25
25 260 285 20
205 95 20 75
265 135 25 110
116
Exercise 14 (contd) Balance Sheets as at 31 December Year 1 000s FIXED ASSETS Premises Plant and machinery Delivery vehicles CURRENT ASSETS Stock Debtors Bank LESS CURRENT LIABILITIES Creditors Bank TOTAL ASSETS FINANCED BY Capital at start Add net profit 750 75 825 825 110 935 Year 2 000s
000s 500 200 100
000s
000s 450 280 160
000s
800 20 18 15
890
25 16 0
41
53
14 2
16
25 825
8 0
45 935
117
Exercise 15 The following information has been provided by the directors of Rannoch Heating plc. Calculate each of the following ratios for both years and suggest one possible reason for any differences: (a) (b) (c) (d) (e) (f) gross profit % net profit % expenses % rate of stock turnover creditors payment period current ratio.
Trading and Profit and Loss Accounts for year ended 30 April Year 1 000s Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit Year 2 000s
000s 500
000s 400
25 275 300 15
15 250 265 20
285 215 50 165
245 155 50 105
118
Exercise 15 (contd) Balance Sheets as at 30 April Year 1 000s FIXED ASSETS Premises Machinery Vehicles CURRENT ASSETS Stock Debtors Bank LESS CURRENT LIABILITIES Creditors Bank TOTAL ASSETS FINANCED BY Capital at start Add net profit 222 165 387 387 105 492 Year 2 000s
000s 100 120 150
000s
000s 150 220 120
000s
370 20 22 0
490
15 8 12
35
42
18 0
18
17 387
26 14
40
2 492
119
Exercise 16 You have been given the following information by the management of Musicmakers plc. Trading and Profit and Loss Accounts for year ended 10 Ap ril Year 1 000s Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit Year 2 000s
000s 180
000s 220
11 98 109 9
9 114 123 13
100 80 20 60
110 110 40 70
(a)
You are required to calculate the following ratios for each of the 2 years: (i) (ii) (iii) (iv) gross profit % net profit % expenses % rate of stock turnover.
(b)
Give one possible reason for any differences that have arisen in the ratios between the two years.
The following Balance Sheets have also been supplied.
120
Exercise 16 (contd) Balance Sheets as at 30 April Year 1 000s FIXED ASSETS Premises Machinery Vehicles Office equipment CURRENT ASSETS Stock Debtors Bank LESS CURRENT LIABILITIES Creditors Bank TOTAL ASSETS FINANCED BY Capital at start Add net profit 150 60 210 210 70 280 Year 2 000s
000s
000s
000s
000s 55 110 70 40 275
100 70 30 200 9 5 8 13 11 0
22
24
12 10 210
9 10
19
5 280
(c)
(i)
Calculate the return on capital employed for Years 1 and 2 and give one reason for any difference in the figures. (ii) Calculate the debtors collection period for both years. Has this figure shown any improvement? (iii) Calculate the creditors payment period for each year. What does this ratio mean? (iv) Calculate the current ratio for each year. Why is this ratio considered to be very important?
121
Financial analysis: suggested solutions to exercises

Exercise 1 Year 1 Return on capital employed 5,000 x 100 50,000 = 10% Year 2 8,100 x 100 54,000 = 15% Year 3 15,000 x 100 60,000 = 25%
Exercise 2 Year 1 Capital at start Add profit 100,000 25,000 125,000 5,000 120,000 Year 2 120,000 24,000 144,000 4,000 140,000 Year 3 140,000 21,000 161,000 6,000 155,000
Return on capital employed 25,000 x 100 100,000 = 25%
24,000 x 100 120,000 = 20%
21,000 x 100 140,000 = 15%
Exercise 3 Year 1 Gross profit % Net profit % Expenses % 33.3% 20% 13.3% Year 2 25% 15% 10% Year 3 30% 20% 10%
122
Exercise 4 Year 1 Sales Less cost of goods sold Gross profit Less expenses Net profit 120,000 90,000 30,000 18,000 12,000 Year 2 160,000 128,000 32,000 8,000 24,000 Year 3 220,000 132,000 88,000 22,000 66,000
Gross profit % Net profit % Expenses %
25% 10% 15%
20% 15% 5%
40% 30% 10%
Exercise 5 Year 1 (a) Gross profit % 32,000 100 80,000 = 40% 16,600 100 80,000 = 20% 16,000 100 80,000 = 20% 6,000 + 8,000 2 = 7,000 48,000 7,000 = 6.85 times Year 2 28,200 100 94,000 = 30% 16,920 100 94,000 = 18% 11,280 100 94,000 = 12% 8,000 + 12,000 2 = 10,000 65,800 10,000 = 6.58 times
(b)
Net profit %
(c)
Expenses %
(d)
Average stock
123
Exercise 6 Year 1 (a) Gross profit % 48 100 120 = 40% Year 2 70 100 140 = 50%
An increase in the gross profit % may be due to: selling at a higher price buying at a lower price a change in the sales mix. (b) Net profit % 30 100 120 = 25% 42 100 140 = 30%
The increase in the net profit % is probably due to the increase in the gross profit %. It is a smaller increase and this may b e because of a rise in expense costs such as advertising. (c) Expenses % 18 100 120 = 15% 28 100 140 = 20%
Selling and administration expenses such as advertising, discounts allowed, salaries, etc. may have risen. (d) Average stock 8 + 6 2 = 7 72 7 = 10.3 times 6 + 10 2 = 8 70 8 = 8.75 times
The rate of stock turnover has dropped which shows that although sales have increased, a higher stock is being held. Stock must therefore be turning over more slowly because of a decrease in actual sales volume.
124
Exercise 7 Black Debtors collection period 12,000 365 150,000 = 29 days 10,000 365 100,000 = 36/37 days White 3,500 365 75,000 = 17 days 2,400 365 48,000 = 18 days Gray 13,200 365 342,500 = 14 days 14,500 365 235,000 = 22/23 days
Exercise 8 Year 1 Debtors collection period 4,600 365 88,500 = 19 days Year 2 7,200 365 96,800 = 27 days
The increase in the debtors collection period may indicate that credit control within the firm has become slack. This may be deliberate to encourage trade but it should be investigated to see if it can be improved. Creditors payment period 2,600 365 54,200 = 17/18 days 2,500 365 68,800 = 13 days
The creditors payment period has decreased, which indicates that creditors are expecting their customers to pay more promptly. It is possible that cash discounts have been offered to encourage this.
125
Exercise 9 Year 1 Current ratio 10,500 3,500 = 3:1 Year 1 Year 2 6,000 3,000 = 2:1 Year 3 5,400 7,200 = 0.75:1
Current ratio is very high a high level of stock may be being carried but there is also a fairly high bank balance which could perhaps be put to better use. This ratio is more normal and acceptable. All current assets have been reduced considerably and some of the bank balance may have been used to buy fixed assets such as machinery. The firm can no longer pay the debts that will shortly fall due. The bank overdraft may have been caused by purchase of a fixed asset when the firm could not afford it.
Year 2
Year 3
Exercise 10 (a) Return on capital employed has improved only slightly, probably due to the increase in the net profit %. Gross profit % has increased considerably, either because selling price has been increased or because the cost price has been decreased by getting better terms or changing suppliers. The net profit % has not increased in accordance with the gross profit %, which suggests that expenses have risen more than is acceptable. This should be investigated to eliminate the trend. Current ratio has increased but it was satisfactory in Year 1. The creditors figure may be lower or it may be that a greater proportion of sales are on credit, thus increasing the debtors figure. Debtors collection period is 7 days longer, which indicates that there is a problem with debtors. There is a greater risk of bad debts when the collection period is too long.
(b)
(c)
(d)
(e)
126
Exercise 11 (a) Gross profit % 12,000 100 48,000 7,200 100 48,000 4,800 100 48,000 7,200 100 12,000 36,000 100 2,400 = 25%
(b)
Net profit %
15%
(c)
Expenses %
10%
(d)
Return on capital employed
60%
(e)
15 times
[average stock = 2,000 + 2,800 ] 2 (f) Current ratio 6,000 2,800 2,000 365 48,000 2,800 365 36,800 = 2.1:1
(g)
Debtors collection period
15 days
(h)
27 days
127
Exercise 12 (a) Gross profit % 10,000 100 40,000 = 25%
Lower than average 27%. Reason: possibly lower selling price (different market, different sales mix) or higher cost price (poor purchasing procedures, missing trade discounts). (b) Net profit % 4,000 100 40,000 = 10%
Slightly higher than average 9.5%. Reason: expenses are being kept under control. (c) Return on capital employed 4,000 100 30,000 = 13.3%
Lower than average 16%. Reason: capital may not be being used efficiently a large amount seems to be tied up in stock and debtors. (d) Rate of stock turnover 30,000 = 5,000 6 times
[average stock = 4,000 + 6,000 ] 2 Lower than average 8 times. Reason: sales activity may be slowing down and stock piling up. (e) Current ratio 14,000 = 12,000 1.16:1
Much lower than average 2:1 dangerously low. Reason: both debtors and creditors figures are high, resulting in poor cash flow and an overdraft at the bank. (Creditors and overdraft result in interest charges.)
128
Exercise 13 (a) (i) Gross profit % 24,000 100 60,000 12,000 100 60,000 14,000 10,000 6,000 365 60,000 8,000 365 40,000 36,000 6,000 = 40%
(ii)
Net profit %
20%
(iii) Current ratio
1.4:1
(iv) Debtors collection period
36/37 days
(v)
73 days
(vi) Rate of stock turnover
6 times
[average stock = 4,000 + 8,000 ] 2 (b) (i) (ii) No difference. Lower: expenses too high, need to be investigated.
(iii) Slightly lower: creditors figure seems rather high; money is lying out in debtors that could be brought in to clear overdraft. (iv) Longer: credit policy too slack; perhaps no provision has been made for bad debts. (v) Shorter than average: does not seem to be taking full advantage of the very long term of credit generally allowed.
(vi) Slower: old stock may be carried and included in figures.
129
Exercise 14 Year 1 (a) Gross profit % 95,000 100 300,000 = 31.7% Year 2 135,000 100 400,000 = 33.75%
This ratio has risen slightly either because of a rise in selling prices or a fall in cost prices. (b) Net profit % 75,000 100 300,000 = 25% 110,000 100 400,000 = 27.5%
This ratio has risen slightly more than the gross profit %, which suggests that expenses have been kept in check. (c) Return on capital employed 75,000 100 750,000 = 10% 110,000 100 825,000 = 13.3%
The increase in net profit is reflected in a slightly higher return, which suggests that sales activity has risen. (d) Debtors collection period 16,000 365 300,000 = 19 days 18,000 365 400,000 = 16 days
Debtors are settling their accounts more quickly either because of a tightening of credit procedures or because greater incentives are being allowed for prompt payment. (e) Current ratio 41,000 16,000 = 2.6:1 53,000 8,000 = 6.6:1
The first year was more satisfactory although even then the ratio was a little high. The high current ratio means that the firm is well able to meet its short-term debts but the high current assets figure must be examined money lying in the bank could be put to work in the business or invested where it would earn a higher rate of interest.
130
Exercise 15 Year 1 (a) Gross profit % Year 2
215,000 100 155,000 100 500,000 400,000 = 43% = 38.75%
This ratio has fallen because the cost of the goods sold is higher, perhaps because of a general rise in prices or a change of supplier. (b) Net profit % 165,000 100 105,000 100 500,000 400,000 = 33% = 26.25%
This ratio has also fallen because of the fall in gross profit but also because expenses have remained the same despite a lower sales figure. (c) Expenses % 50,000 100 500,000 = 10% 50,000 100 400,000 = 12.5%
Economies have not been made in running expenses despite the fact that sales were lower. (d) Rate of stock turnover 285,000 20,000 = 14.3 times 245,000 17,500 = 14 times
There is little change in the number of times stock is turning over in the year. (e) Creditors payment period 18,000 365 275,000 = 24 days 26,000 365 250,000 = 38 days
The firm is taking advantage of longer credit periods from its suppliers, but must take care not to lose out on discounts. (f) Current ratio 35,000 18,000 = 1.9:1 42,000 40,000 = 1.05:1
The current ratio has gone from being satisfactory to risky. The high debtors figure means a probability of bad debts arising. High creditors and overdraft are possibly costing money.
131
Exercise 16 (a) (i) Gross profit % Year 1 80,000 100 180,000 = 44% 60,000 100 180,000 = 33% 20,000 100 180,000 = 11% 100,000 10,000 = 10 times Year 2 110,000 100 220,000 = 50% 70,000 100 220,000 = 32% 40,000 100 220,000 = 18% 110,000 11,000 = 10 times
(ii)
Net profit %
(iii) Expenses %
(iv) Rate of stock turnover
(b) (i) Gross profit % has increased because of lower purchase prices or increased selling prices. Net profit % has not increased in proportion to gross profit % because expenses have been allowed to increase.
(ii)
(iii) As in (ii), expenses have risen out of proportion to the increased sales. (iv) No difference.
132
(c) (i) Return on capital employed 60,000 100 150,000 = 40% 70,000 100 210,000 = 33%
The increased expenses have caused this ratio to fall despite increased sales. (ii) Debtors collection period 5,000 365 180,000 = 10 days 11,000 365 220,000 = 18 days
No, debtors are taking longer to settle their bills in Year 2. (iii) Creditors payment period 12,000 365 98,000 = 45 days 9,000 365 114,000 = 29 days
This ratio shows the credit period allowed to Musicmakers plc by suppliers. (iv) Current ratio 22,000 12,000 = 1.8:1 24,000 19,000 = 1.3:1
This ratio is important because it indicates the firms ability to settle its short-term debts. Current assets should ideally be about twice as much as current liabilities but this varies from firm to firm. If current assets do not cover current liabilities, the firm may be in danger of going bankrupt and having to close.
133
Financial analysis: extension exercises

Exercise E1 The following figures have been supplied by H Cowan, who is concerned at the fall in profits. Balance Sheets as at 31 December Year 1 Year 2 FIXED ASSETS Premises 60,000 60,000 Machinery 12,000 7,000 Vehicles 10,000 8,000 Office equipment 82,000 3,000 78,000 CURRENT ASSETS Stock 4,000 6,250 Debtors 2,000 4,000 Bank 2,000 8,000 1,250 11,500 LESS CURRENT LIABILITIES Creditors 7,000 4,500 Bank 1,000 7,000 TOTAL ASSETS FINANCED BY Capital at start Add net profit 70,000 14,400 84,000 1,400 83,000 83,000 3,200 86,200 1,200 85,000 83,000 85,000
Less drawings
Answer each of the following questions. (a) (b) (c) (d) (e) (f) (g) How much is the return on capital employed for each year? Give one possible reason for the fall in this ratio. Suggest 2 possible remedies for falling profits. What is the current ratio for each year? Which current ratio is considered to be more satisfactory? Explain the danger of a current ratio that is too low. Give a reason for the fall in value of the machinery and the vehicles.
134
Exercise E2 The following figures have been prepared by M Davids on for the 2 years ended 31 May. Trading and Profit and Loss Accounts for year ended 31 May Year 1 Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit Year 2
40,000
48,000
2,500 32,000 34,500 4,500
4,500 32,700 37,200 5,200
30,000 10,000 8,000 2,000
32,000 16,000 12,000 4,000
(a)
Calculate the following ratios for both years: (i) gross profit % (ii) net profit % (iii) rate of stock turnover.
(b)
Answer each of the following questions. (i) (ii) Give one possible reason for the change in the gross profit %. In which year was M Davidson more economical with expenses for the sales level? Give a reason for your answer.
(iii) What is meant by rate of stock turnover?
135
Exercise E2 (contd) M Davidson has also supplied the following Balance Sheets. Balance Sheet as at 31 May Year 1 FIXED ASSETS Premises Machinery Vehicles Office equipment CURRENT ASSETS Stock Debtors Bank LESS CURRENT LIABILITIES Creditors Bank TOTAL ASSETS FINANCED BY Capital at start Add net profit 21,000 2,000 23,000 1,000 22,000 (c) 22,000 4,000 26,000 1,500 24,500 Year 2
8,000 7,000 4,000 19,000
7,000 12,000 3,000 22,000
4,000 5,250 3,750 13,000
4,000 4,500 500
9,000
4,500 5,500 10,000
3,000 22,000
3,000 3,500
6,500
2,500 24,500
Less drawings
Using the above information and your answers to (a), calculate the following ratios: (i) (ii) (iii) (iv) return on capital employed current ratio debtors collection period creditors payment period.
(d)
Answer each of the following questions. (i) (ii) The ideal current ratio is considered to be 2:1. Suggest one possible reason for Davidsons fairly low current ratio. What is meant by debtors collection period and what could be offered to customers to try to improve this figure?
136
Exercise E3 The management of Quality Doors plc has provided the figures below. Trading and Profit and Loss Accounts for year ended 31 August Year 1 000s Sales Less cost of goods sold Stock at start Add purchases Goods available Less stock at end Gross profit Less expenses Net profit Year 2 000s
000s 200
000s 240
2 146 148 4
4 184 188 8
144 56 36 20
180 60 26 34
137
Exercise E3 (contd) Balance Sheet as at 31 August Year 1 000s Cost FIXED ASSETS CURRENT ASSETS Stock Debtors Bank LESS CURRENT LIABILITIES Creditors NET CURRENT ASSETS TOTAL ASSETS FINANCED BY Capital at start Add net profit 80 20 100 (a) 100 34 134 100 Year 2 000s Cost 134
000s Agg Dep 12
000s Book Value 88
000s Agg Dep 16
000s Book Value 118
4 10 5
19
8 12 2
22
7 12 100
6 16 134
You are required to calculate the following ratios for both years and give one possible reason for any differences that have arisen between the two years. (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) Gross profit % Net profit % Expenses % Rate of stock turnover Return on capital employed Current ratio Debtors collection period Creditors payment period
138
Exercise E3 (contd) (b) Answer each of the following questions. (i) (ii) Why is it important for the firm to know the current ratio? What is meant by the rate of stock turnover?
(iii) How does the calculation of ratios help in showing if a firms performance is satisfactory for its line of business?
139
Financial analysis: suggested solutions to extension exercises

Exercise E1 (a) Return on capital employed Year 1 14,400 100 70,000 = 20.6% Year 2 3,200 100 83,000 = 3.9%
(b)
Sales may have fallen unexpectedly; increase in costs; increase in expenses. An advertising campaign may increase sales; economies in expenditure; market research to find new products; change suppliers. Current ratio Year 1 8,000 7,000 = 1.14:1 Year 2 11,500 4,500 = 2.5:1
(c)
(d)
(e) (f)
Year 2 is more satisfactory. A low current ratio means that the firm is in danger of being unable to pay its short-term debts, in which case it will be bankrupt. The charge for depreciation is the reason for the fall in value of these assets.
(g)
140
Exercise E2 Year 1 (a) (i) Gross profit % 10,000 100 40,000 = 25% 2,000 100 40,000 = 5% 30,000 3,500 = 8.6 times 16,000 100 48,000 = 33.3% 4,000 100 48,000 = 8.3% 32,000 4,850 = 6.6 times Year 2
(ii)
Net profit %
(iii) Rate of stock turnover
(b) (i) (ii) Selling prices have increased or cost prices have decreased. In Year 1: the difference between gross profit % and net profit % (the expenses %) is 20% in Year 1 and 25% in Year 2.
(iii) Rate of stock turnover means the number of times that stock is bought in and sold in a year. (c) (i) Return on capital employed 2,000 100 21,000 = 9.5% 13,000 10,000 = 1.3:1 5,250 365 40,000 = 48 days 4,500 365 32,000 = 51 days 4,000 100 22,000 = 18% 9,000 6,500 = 1.4:1 4,500 365 48,000 = 34 days 3,000 365 32,700 = 33 days
(ii)
Current ratio
(iii) Debtors collection period
(iv) Creditors payment period
141
Exercise E2 (contd) (d) (i) Davidson has bought new machinery for which it seems he had to borrow money. The debtors collection period is the average time taken by debtors to settle their bills. Cash discounts could be offered to encourage prompt payment.
(ii)
142
Exercise E3 (a) Year 1 (i) Gross profit % 56,000 100 200,000 = 28% Year 2 60,000 100 240,000 = 25%
Reason: although the sales figure has increased, purch ases have cost proportionately more, resulting in a decrease in gross profit %. (ii) Net profit % 20,000 100 200,000 = 10% 34,000 100 240,000 = 14.2%
Reason: this ratio has increased because expenses have fallen even though sales were higher. (iii) Expenses % 36,000 100 200,000 = 18% 26,000 100 240,000 = 10.8%
Reason: expenses are lower although turnover has increased. (iv) Rate of stock turnover 144,000 3,000 = 48 times 180,000 6,000 = 30 times
Reason: a slowing down in sales activity means that stock is not being replenished so often. The stock figure may therefore include obsolete stock that is still being carried. (v) Return on capital employed 20,000 100 80,000 = 25% 34,000 100 100,000 = 34%
Reason: this ratio has increased because the net profit % has increased. (vi) Current ratio 19,000 7,000 = 2.7:1 22,000 6,000 = 3.7:1
Reason: the current ratio is higher because of the high stock level being carried.
143
Exercise E2 (contd) (vii) Debtors collection period 10,000 365 200,000 = 18 days No change. (viii) Creditors payment period 7,000 365 146,000 = 18 days 6,000 365 184,000 = 12 days 12,000 365 240,000 = 18 days
Reason: creditors are tightening their credit control policies and debts must be settled more quickly. (b) (i) The current ratio shows whether or not the firm is able to settle debts that will fall due within the next few months. If it cannot pay these it may be insolvent and have to close. Rate of stock turnover means the number of times the stock is turned over or bought in and sold in a year.
(ii)
(iii) A firm can compare its own ratios with those of its competitors or with those of an average firm in the same line of bus iness.
144

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NATIONAL QUALIFICATIONS CURRICULUM SUPPORT

Accounting and Finance

Section One Section Two Section Three

Break-even Analysis Profit Maximisation Financial Analysis

1-53 57-94 97-144

19-27 28-30 31-47 48-53

300 400 500

200 200 200

12 20 Total costs Sales revenue Profit (loss)

0 500 1,000 1,500 2,000 2,500 3,000

(a) Break-even point

= 1,500 units or 30,000 sales revenue.

0 500 1,000 1,500 2,000 2,500 3,000 (a) (b)

Break-even point Margin of safety

Profit at 2,500 units

Constructing a break-even chart

Suggested solution to Task 3(a)

Suggested solution to Task 3(b)

Break-even charts: exercises

Find the profit at output levels of 500 and 700 units.

Find the profit at outputs of 5,000 and 7,000 units.

(a) (b) (c)

What revenue is received from

(a) (b) (c)

Break-even charts: suggested solutions to exercises

Break-even point Profit at 500 units Profit at 700 units

= 400 units; 10,000 = 1,000 = 3,000

= 4,000 units; 96,000

Profit at 5,000 units = 12,000 Profit at 7,000 units = 36,000

Break-even point Profit at 6,000 units Profit at 8,000 units

= 4,000 units; 160,000 = 30,000 = 60,000

Break-even point Profit at 4,000 units Profit at 6,000 units

= 3,000 units; 120,000 = 20,000 = 60,000

Break-even point Profit at 6,000 units Profit at 7,000 units

= 5,000 units; 150,000 = 8,000 = 16,000

Contribution in break-even analysis calculation of BEP

At break-even point, total contribution equals total fixed costs.

Contribution in break-even analysis calculation of profit

200 200 200 200 200

Contribution in break-even analysis calculation of required output

= Profit required Unit contribution Number of profitable units = = =

= Total output required = = =

Break-even analysis: theory questions

Question 2 List 4 assumptions made in the use of break-even analysis.

Break-even analysis: suggested solutions to theory questions

Contribution in break-even analysis: exercises

80 120 100 686,000

Contribution in break-even analysis: suggested solutions to exercises

B Benson 8.50 4.50 4.00

C Cameron 11.80 6.80 5.00

6.00 3.00 3.00

= 1,500 units (c) Sales revenue 1,500 6 = 9,000

1,600 8.50 3,500 11.80 = 13,600 = 41,300

Exercise 2 (a) Contribution per unit = selling price variable costs = 40 22 = 18

fixed costs unit contributi on

Margin of safety (i)

fixed costs unit contributi on

Margin of safety (i)

Exercise 4 (a) Contribution per shirt = selling price variable costs = 21 11 = 10

fixed costs unit contributi on

= 3,300 units (c) Sales revenue = 21 3,300 units = 69,300

Contribution per shirt = 22 11 = 11 Break-even point =