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An in-depth exploration of limiting factors and break-even analysis. Learn how to maximize contribution by allocating scarce resources to products with the highest contribution per unit. Discover the concept of break-even analysis and its importance in understanding profit points. topics such as limiting factor analysis, break-even charts, profit/volume graphs, and more.
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Syllabus Content
D - Marginal costing and decision-making – 15%
Contribution concept.
Limiting factor analysis.
Break-even charts, profit/volume graphs, break-even point, profit target, margin of safety, contribution/sales ratio.
7.1 Limiting factors
A limiting factor (or principle budget factor) is a scarce resource which is in short supply. Limiting factor analysis is a technique which will maximise contribution for an organisation, by allocating a scarce resource that exists to producing goods or services that earn the highest contribution per unit of scarce resource available.
Examples of limiting factors
Steps to maximise contribution given the existence of a limiting factor
1. Work out the contribution per unit for each product produced.
Contribution per unit = Sales price less variable cost per unit.
2. Divide the contribution per unit for each product, by the quantity of scarce resource required to make it.
Contribution earned per unit of scarce resource for each product = Contribution per unit for each product Quantity of scarce resource required to make it
3. Rank the different products in order of how much contribution they earn per unit of scarce resource. Produce first the products that earn the highest contribution per unit of scarce resource, subject to the constraint of maximum demand.
Example 7.
Because of intense competition, there is huge pressure on waiting lists for FJs and therefore Cosmetics R Us must fulfil all of these operations first (before undertaking any GT or LS operations), otherwise the reputation of the business could suffer.
Calculate the number of operations that Cosmetics R Us would perform if this were the case?
7.2 Break even analysis or cost volume profit (CVP) analysis
Break even or CVP analysis calculates a physical quantity of units or sales value that would earn no profit and no loss for an organisation. This will help the organisation to understand how many units of a product or service they would need to sell before they can earn profit. There are a number of formulae within this chapter that you need to be able to learn and apply.
To break even would mean an organisation would be earning no profit and no loss.
Sales revenue = Variable + Fixed cost
A variable cost is a cost that can be avoided if a unit is not produced or would be incurred if a unit was produced. A fixed cost remains constant whether a unit is or is not produced.
Assumptions of break even analysis
Break-even charts
0
Profit volume charts
Loss = fixed costs at zero sales activity
Break- even point
Sales
Loss £
£
Profit
0
Example 7.
Z-Boxes sell for £299 and the variable cost of production is £99 a unit. Fixed production overhead for the year is £1.2 million.
a) Calculate the break-even level of sales for both volume and revenue? b) Calculate the break-even revenue using the C/S ratio? c) The budgeted sales revenue is £2.99 million; calculate the margin of safety in units and as a percentage? d) Produce a break-even chart and profit-volume chart using the information above? e) How many Z-Boxes must be sold in order to achieve £500,000 profit?
Example 7.
FJ GT LS
Labour hours per operation ***** 3.0 0.5 1.
Contribution per operation (£) 900 1,150 950
Contribution per hour (£) 300 2,300 633
RANKING 3 rd^1 st^2 nd
***** Surgeon cost per hour for each operation ÷ £500 per hour
To maximise contribution and therefore profit the quantities of each service performed would be as follow;
1 st^ GT 0.5 Hrs x 2000 max demand = 1000 Hrs 2 nd^ LS 1.5 Hrs x 3000 max demand = 4500 Hrs 3 rd^ (28100 Hrs remaining/3 Hrs an operation 9367 operation performed x 3 Hrs = 28100 Hrs 33600 Hrs
Budgeted profit will be £4.58 million
£000s FJ 9367 x (£3,000-£2,100) = 8,430. GT 2000 x (£1,500-£350) = 2,300. LS 3000 x (£2,000-£1,050) = 2,850. Contribution 13,580. Fixed cost (£750,000 x 12 months) (9,000.0) Profit 4,580.
Note: An alternative method could have been used above for the calculation of budgeted profit e.g. on the basis of total surgeon hours x contribution per hour for each service.
Example 7.
FJ ( NO CHOICE ) 10000 x 3 Hrs = 30000 GT 2000 x 0.5 Hrs (most profitable next) 1000 LS 2600 Hrs (balance)/ 1.5 Hrs = 1733 operations x 1.5 Hrs 2600 33600
Note: if you produced a budget now, the profit would be lower due to less profitable FJ being substituted for more profitable LS.
