Page 3 - CIMA OCS Workbook February 2019 - Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

EXERCISE TWO (DECISION MAKING)
To: Sally Gomez (Sales Director)
From: You
Subject: RE: Favour

Interpretation of the multi-product break-even chart

The graph (“chart”) that Ping has created is known as a multi-product break-even chart. The
horizontal axis here shows revenue, while the vertical axis shows the resulting profit or loss at
different levels of activity.
Point A:

Point A is the point at which there is no revenue, where sales volumes are nil. At this point fixed
costs will still be incurred because by their very nature these costs are incurred regardless of
production or activity levels. This means that where revenue is nil a loss will be generated equal
to the amount of fixed costs.
From the chart and accompanying table we can see that the level of budgeted fixed costs for 2019
is approximately F$4.5m. These are the costs that need to be covered by contribution before a
profit can be made, so without any revenue a loss of F$4.5m would be made.
Point C:
At the other extreme point C represents the total revenue and profit that is expected for 2019
based on the expected sales volumes for each revenue stream, the contribution and the fixed
costs.
The chart and accompanying table indicates that sales revenue of approximately F$20.9m is
expected which would generate an operating profit of approximately F$1.8m.
The difference between the two lines from A to C:

The straight line between points A and C represents the expected profit or loss at different
revenue levels assuming that the mix of sales that we expect is kept the same regardless of the
level of total revenue. Based on the budgeted figures this would be a standard mix of 64%
domestic sales and 36% commercial sales.
The line which connects points A, B, and C is the line that represents the relationship between
revenue and profit or loss on the assumption that we generate revenues in order of profitability
(measured as the c/s ratio).
Point B
Point B is at a sales volume between zero (point A) and the total expected sales of point C. This
point is plotted taking into account products in order of both size and profitability where
profitability is measured on the basis of the c/s ratio.
The c/s ratio is essentially the margin of contribution to sales price for each revenue stream and
indicates for every C$1 of revenue generated, how much that will contribute towards the fixed
costs of the business.
Point B on the chart is therefore the point at which we have included all revenue from commercial
sales (as they have the highest c/s ratio at 38%) but no revenue from domestic sales. These are
then incorporated in the line segment BC. The fact that the gradient of the line AB is greater than
that of BC reflects the fact that commercial sales have a higher C/S ratio than domestic sales.
Clearly, if we could raise revenue from commercial clients first, then domestic sales, then we will
cover the fixed costs more quickly than if we were to gain revenue in the budgeted mix.

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