Example of profit Range

Example of profit Range

There are two products which have maximum demand of 5000 units and minimum demand of 3000 units and company has a fixed cost of 50,000. The product has the following selling price and variable cost.

	Product A	Product B
Sales	150	170
Variable Cost	80	80
Maximum demand	5000 unit	5000 unit
Minimum Demand	3000 unit	3000 unit

Calculate the profit possibilities for Sara and co.

Solution

Contribution

Sales	150	170
Variable Cost	80	80
Unit Contribution	70	90

1. Favorable Condition (Maximum Demand)

	Unit contribution	Unit sold	Total Contribution
Product A	80	5000	40,000
Product	90	5000	45000
Total Contribution			85000
Fixed Cost			(50,000)
Profit			35,000

2. Minimum Demand Condition

	Unit contribution	Unit sold	Total Contribution
Product A	80	3000	24,000
Product	90	3000	27,000
Total Contribution			51,000
Fixed Cost			(50,000)
Profit			1,000

The company profit range will be between 35,000 and 1000 .

Break-even Point

Contribution

Sale unit price is constant and variable cost is also constant therefore each unit sold result in a unit profit which is known as contribution and the formula of calculating unit contribution.

Contribution = Sales – Variable cost

Conceptually the fixed cost is a period cost and therefore we must generate enough contribution to cover fixed cost. This situation where we able to cover over fixed cost are known as break-even point. This point is also known as no profit no loss situation.

Example of Break even

Sale Price = 20

Variable Cost = 16

Fixed Cost = 40,000

What is break-even point?

Solution

Unit contribution = 20-16

Unit contribution = 4

Required level =                      fixed Cost/unit Contribution

                          =          40,000/4

                         =           10,000 units

Desired Level Profit

The concept of break even may be further extended to get the desired level of profit and the formula is amended as below

Desired level of profit = (Fixed Cost + Desired Level of profit)/unit contribution

Example of Desired level of Profit

Example of Break even

Sale Price = 20

Variable Cost = 16

Fixed Cost = 40,000

Desired level of profit = 70,000

What is required contribution?

Solution

Unit Contribution = 20-16

                              = 4

Required level of contribution:    (40,000+70,000)/4

                                                         = 110,000/4

                                                         = 27,500 units

Margin of Saftey

What is Margin of safety

Margin of safety is difference between the budget unit and break even. This difference may be  expressed in term of unit, revenue or percentage of budgeted figure.

What is formula of Margin of Safety

Formula =      i) Budgeted (units) – Break even (unit)

                = ii )  Budgeted (Revenue) – Break Even (Revenue)

Purpose of calculating the margin of Safety

The main purpose of calculating the margin of safety is to determine the risk factor. In simple term margin of safety tell what margin you have before the profit fall down at a level of break even a situation and that margin can be express either in terms of unit, revenue or as percentage of budgeted .

Example of Margin Safety

Sale Price = 20

Variable Cost = 16

Fixed Cost = 40,000

Budgeted unit are 25,000

What is Margin of Safety in terms of unit and percentage?

First place we will calculate the break even

= 40,000/(20-16)

= 10,000 units

Margin of safety = 25,000-10,000

                              = 15,000 units

Margin of safety in % = 15,000 units/ 25,000 units

                                      = 60%