2015 DMC2523 Topic 9 cost control-profit relationship

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Information about 2015 DMC2523 Topic 9 cost control-profit relationship

Published on September 25, 2015

Author: LauraLaw1028

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2. • The important of the relationship • Breakeven point • Calculating average variable rate LAURA LAW - PERAK COLLEGE OFTECHNOLOGY Handout Copy of Text Book

3. 3 Introduction The Key to understand cost/volume/profit relationship lies in understanding that fixed costs exist in an operation regardless of sale volume and that it is necessary to generate sufficient total volume to cover both fixed and variable costs as well as desired profit. It should be apparent that relationship exist between and among sales, cost of sales, cost of labor, cost of overhead and profit. In fact these relationship can be expressed as follows: Sales = Cost of sales + Cost of labor + cost of overhead + profit.

4. 4 The relationship formula Because cost of sale is variable, cost of labor includes fixed and variable elements and cost of overhead is fixed, one should restate this equation as follows: S = VC + FC + P In fact this is the basic equation of cost/volume/profit analysis S = Sales VC = Variable Cost FC = Fixed Cost P = Profit.

5. 5 Three guideline of references to remember 1. Within the normal range of business operations, there is a relationship between variable costs and sales that remains relatively constant. That relationship is a ratio that is normally expressed either as a percentage or as a decimal point. 2. By Contrast, fixed costs tend to remain constant in dollar terms, regardless of changes in dollar sales volume. Consequently, whether expressed as a percentage or as decimal, the relationship between fixed costs and sales changes as sales volume increase or decrease. 3. Once acceptable levels are determined for costs, they must be controlled if the operation is to be profitable.

6. COST OF SALES Food 96,678.00 Beverage 12,188.00 PAYROLL 81259.00 OTHER CONTROLLABLE EXPENSES 46,750.00 OCCUPANCY COST 29,500.00 INTEREST EXPENSES 5,000.00 DEPRECIATION 16,250.00

7. 7 Step (1). Determine total variable cost Total variable cost consists of food cost, beverage cost, and the variable portion of labor cost. We will assume that labor cost is $81259.00 40% variable and 60% fixed. Food Cost 96,678.00 Beverage Cost 12,188.00 Variable labor Cost (40%) 32,503.60 Total Variable Cost 141,369.60

8. 8 Step (2) Determine total fixed cost Fixed labor Cost (60%) $48,755.40 Other Controllable Exp. 46,750.00 Occupancy Cost 29,500.00 Interest 5,000.00 Depreciation 16,250.00 Total Fixed Cost 146,255.40 Profit desired is $37,375.00 The basic cost/volume/profit equation at the level of sales is: S=VC(141,369.60)+FC(146,255.40)+P(37,375) S=$325,000.00

9. 9 Variable Rate is the ratio of variable cost to dollar sales. It is obviously determined by dividing variable cost by dollar sales and is expresses in decimal form. Variable Rate (VR) = Variable Cost / Sales or VR = VC / S VR= VC (141,375) / S (325,000) VR=.435 43.5 percent of dollar sales is needed to cover the variable costs, or that $0.435 of each dollar of sales is required for that purpose.

10. 10 If 43.5% of dollar sales is needed to cover VC, then the remainder 56.5% is available for other purpose: 1. Meeting Fixed Costs 2. Providing Profit Thus, $0.565 of each dollar of sales is available to contribute to covering fixed costs and providing profit. This percentage (or ratio, or rate) is known as the Contributing rate or CR. # The contributing rate is determined by subtracting the variable rate from 1. CR = 1 - VR = 1 - .435 = .565

11. 11 No business can be termed profitable until all of the fixed cost have been met. • if sales cannot cover both variable cost & fixed cost it is operating at a loss • if sales can cover both variable cost & fixed cost exactly but insufficient to provide any profit. (I.e, profit = 0) the business is said to be operating at the breakeven point (BE) Changing the Breakeven Point Two ways to change Breakeven point is by 1. Increase menu price 2. Reduce Variable cost

12. 12 Gather all the information that have been calculated Sales = 325,000.00 VC = 141,375.00 FC = 146,250.00 Profit = 37,375.00 VR = .435 CR = .565 Sales = or This formula can be used to determine the level of dollar sales required to earn any profit that one might choose to put into the equation. Fixed Cost + Profit Contribution Rate S= FC + P CR 146,250 + 37,375 .565 Sales = 325,000 Sales =

13. 13 By using the same formula, we can actually can determine the Breakeven point, a which profit would be equal to zero dollar Sales = $146,250 + 0 .565 S = FC + P CR Sales = $258,849.55 rounded as = $258,850.00 At this level VC is 43.5% of sales = 112,599.75 or 112,600.00 (S)$258,850 = (VC)$112,600 + (FC)$146,250 +(P)$0.00

14. 14 The Graduate Restaurant achieved sales level of $325,000, which was $66,150 beyond BE. At this level, beyond BE, there are no more fixed cost to be cover for each dollar of sales but have variable cost. Variable Cost can be determined by multiplying S (Sales) by VR (Variable Rate) = .435 VC = S X VR (VC) $28,775 = (S) $66,150 X (VR) .435 If $28,775 in VC is subtracted from sales of $66,150 the result $37,375 is equal to profit (P). It consist of $0.565 of each dollar sales beyond BE. (P) $37,375 = (S) $66,160 x (CR) .565

15. 15 Each dollar of sales, may also be divided in two portions. 1. That which must be used to cover variable cost associated with the item sold. 2. That which remains to cover fixed costs and to provide profit. The dollar amount remaining after VC have been subtracted from the sales dollar is defined as the Contribution Margin (CM). Contribution Margin must go to cover all fixed and variable cost until breakeven is reached, after breakeven is reached, contribution margin becomes profit. Sales - Variable Cost = Contribution Margin

16. 16 Certain assumptions that need to be understand in C.V.P analysis are: 1. Cost is a particular establishment can be classified as fixed and variable with reasonable accuracy. 2. Variable cost are directly variable 3. Fixed cost are relatively stable and will remain so within the relevant range of business operations 4. Sales prices will remain constant for the period covered by the analysis 5. The sales mix in the restaurant will also remain relatively constant for the period.

17. 17 The questions that we want to answer through CVP analysis are likely to be: •What profit will be established earn at a given sales level? •What level of sale will be required to earn in given profit? •How many sales (or cover) will be required in order to reach the breakeven point? The question that con be sort into the different categories: 1. Those requiring answer stated in term of money 2. Those requiring answer stated in term of number of sales.

18. 18 Formula # 1 Formula to determining the dollar sales level required to earn any planned or targeted profit, given a dollar total of fixed cost and an expected variable rate (VR) This formula can also be use to determine BE by P = 0 Formula # 2 CR = FC + P/S Formula # 3 P = (S X CR) – FC Formula # 4 FC = (S X CR) – P S = FC + P 1 - VR (or CR)

19.  the total of the contribution margins for all sales is used to cover fixed costs and provide a profit. If one knows the average contribution margin per sale and the dollar figure for fixed costs, it is then possible to calculate the number of sales, or customers, needed to cover fixed costs and the desired profit.  For example, if the financial records of a small restaurant indicated  sales of $48,000 and variable costs of $18,000 in a period when 3,000 customers were served, then: 48,000 sales ÷ 3,000 customers = $ 16.00 average sales 18,000 variable costs ÷ 3,000 customers = $ 6.00 average variable costs

20.  determine average contribution margin Average S $16.00 - Average VC 6.00 = Average CM $10.00  BEP in Customers = FC ÷ Average CM  to determine the number of customers required to achieve a given profit, one simply adds profit to fixed cost and divides by average contribution margin.  Number of Customers = FC + Profit ÷ Average CM  Assume that fixed cost for the period was $30,000 Number of Customers = $30,000 ÷ $10 3,000 customers

21. 1. Given the following information, determine total dollar sales: a. Cost of sales, $46,500; cost of labor, $33,247; cost of overhead, $75,883; profit, $3,129. b. Cost of sales, $51,259; cost of labor, $77,351; cost of overhead, $42,248; loss, $41,167. 2. Given the following information, find contribution margin: a. Average sales price per unit, $13.22; average variable cost per unit, $5.78 b. Average sales price per unit, $14.50; average variable rate, .36 c. Average sales price per unit, $16.20; average contribution rate, .55

22. 3. Given the following information, find variable rate: a. Sales price per unit, $19.25; variable cost per unit, $6.70 b. Total sales, $164,328; total variable cost, $72,304.32 c. Sales price per unit, $18.80; contribution margin, $10.72 d. Sales price per unit, $16.37; total fixed costs, $142,408; total unit sales, 19,364; total profit, $22,952.80 4. Given the following information, find contribution rate: a. Sales price per unit, $18.50; contribution margin, $10.08 b. Sales price per unit, $17.50; variable cost per unit, $6.95 c. Total sales, $64,726; total variable cost, $40,130.12

23. 5. Given the following information, find break - even point in Number of Customers: a. Fixed costs, $113,231.64; contribution margin, $2.28 b. Sales price per unit, $17.22; fixed costs, $215,035.68; variable cost per unit, $6.98. 6. Given the following information, find number of customers: a. Fixed costs, $58,922; profit, $9,838; contribution margin per unit, $3.82 b. Variable cost per unit, $5.30; profit equal to 18 percent of $211,000; sales price per unit, $16.30; fixed costs, $86,609

24. Food Costs RM188,625 Variable Labor Costs RM61,200 Occupancy Costs RM55,500 Interest RM20,025 Depreciation RM33,750 Beverage Costs RM 42,750 Fixed Labor Costs RM85,575 Other Controllable Expenses RM 76,500 a) What is the establishment’s profit or loss if sales are RM595500? b) Calculate the variable rate? c) Calculate the contribution rate? d) Calculate the breakeven point in dollar sales e) What level of dollar sales is required in order to earn a profit of RM75000 f) If the establishment operated at a loss of RM33375 last year, what was its level of dollar sales?

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