Page 3 - CIMA OCS August 2018 Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

EXERCISE TWO (DECISION MAKING)
To: Ben Jones (Sales and Marketing Director)
From: You
Subject: RE: Favour

Interpretation of the multi-product break-even chart

The graph that Ana 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.

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 approximatelyD$49m. These are the costs that need to be covered by contribution before a
profit can be made, so without any revenue a loss of L$49m would be made.
Point D:

At the other extreme point E 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 approximatelyD$144m is
expected which would generate an operating profit of approximately D$27m.

The difference between the two lines from A to D:
The straight line between points A and D 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.

The line which connects points A, B, C, and D 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).
Points B and C:

Points B and C are at sales volumes between zero (point A) and the total expected sales of point
D. Each of these points 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 D$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 sales of green teas (as
they have the highest c/s ratio at 58.0%) but no other revenue. Point C is the cumulative position
where all black tea sales are also included as they have the next highest c/s ratio of 53.2%.
Clearly, if we could raise revenue from green teas first, then black teas and so on, then we will
cover the fixed costs more quickly than if we were to gain revenue in the budgeted mix.

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