Page 4 - CIMA MCS Workbook August 2018 - Day 2 Suggested Solution

CIMA NOVEMBER 2018 – OPERATIONAL CASE STUDY

Points marked as F:

Points marked as F 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 is where revenue is
approximately C$72m.
This means that revenue can fall to this level from the expected level of C$92m 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 22% before we no longer make a profit.

The line ABCDE has a different break-even point to the straight line AE. Here the break- even
position is where revenue is approximately C$70m. This means that revenue could fall to this
from the expected total of C$92m 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 22% and we face challenges
attracting and retaining members in the face of high competitive pressure. 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 ABCDE, however, is less useful as we do not have the option of prioritising
products - it is nonsensical to suggest we would only consider allowing students to join once
targets for full fee members had been achieved. Likewise, it would not make commercial sense to
suggest that we only open a vending machine once membership quotas had been reached.

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 do not incorporate any gain in customers due to
government initiatives, 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).

Nicola’s comments
One of the main things to come out of Nicola’s graph is that full fee sales (line segment AB)
generate the greatest contribution and are nearly sufficient to break even on their own. In that
respect we are highly dependent on full fee members. This adds extra emphasis to the need to
strengthen the customer experience through highly trained staff and the use of IT.

I addressed the issue of safety margin above – revenue can fall by 22% before a loss results.
Other income streams have the lowest c/s ratio and this is reflected by the line DE having a lower
gradient than AB (full fee), BC (students) or CD (classes). In that respect it could be said that the
performance of other income is disappointing, emphasising the need to be able to either put up
prices for day passes or reducing costs (say by negotiating better arrangement with vending
machine suppliers).
Whether new customer groups are 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 C$16m profit.

60 KAPLAN PUBLISHING