Page 4 - CIMA OCS Workbook February 2019 - Day 2 Suggested Solutions

CIMA FEBRUARY 2019 – OPERATIONAL CASE STUDY

Points marked as D:

Points marked as D are the break-even points on each line. These are the points at which neither
a profit nor a loss is expected to be made.
Looking at the chart one can see that the break-even point on the straight line AC is where
revenue is approximately F$15m.
This means that revenue can fall to this level from the expected level of F$21m before we reach
the point where fixed costs are not covered by contribution. The margin of safety is the amount
by which revenue can fall from the expected revenue before a loss is made, usually measured as a
percent - here, revenue can drop by approximately 28% before we no longer make a profit.

The line ABC has a different break-even point to the straight line AC. Here the break- even
position is where revenue is approximately F$13m. This means that revenue could fall to this from
the expected total of F$21m before a loss starts to be made.
The usefulness of this multi-product break-even chart

Overall the chart is useful because it gives an idea of the level of revenue at which we will make
neither a profit nor a loss.

This is particularly relevant as the safety margin is reasonably low at 28% and we face challenges
in both the domestic and commercial market segments. The graph could be used to emphasise
the need to boost revenue and/or reduce fixed costs to reduce the risk of becoming loss-making.

The multi-product line ABC, however, is less useful as we do not have the option of prioritising
products - it is nonsensical to suggest we would only consider selling direct to the public once
targets for commercial sales had been met.
In addition, the graph has all domestic sales put together rather than showing sales for deluxe
towers distinct from basic towers, for example.

Furthermore, there are some factors which limit the usefulness of this break-even analysis that
you need to be aware of:

1. The figures used are estimates only and may not incorporate any gain in customers due to
government initiatives, such as KITKIDS, for example.

2. The analysis assumes that we can define costs as fixed or variable. In reality all costs are
variable in the long term and even in the short term many costs that we think of as variable are
fixed (for example, labour costs).

Ping’s comments
One of the main things to come out of Nicola’s graph is that commercial sales (line segment AB)
are not sufficient to break even on their own, so in that respect we are still highly dependent on
domestic sales. This shows that we must be careful not to neglect domestic customers in our
pursuit of new commercial work..
I addressed the issue of safety margin above – revenue can fall by 28% before a loss results.

Whether growth in commercial sales is needed, rather than just being desirable, is debatable.
Certainly they could increase the safety margin and boost profit, but even with current figures we
are forecast to make nearly F$2m profit.

60 KAPLAN PUBLISHING