Page 5 - OCS Workbook - Day 2 Suggested Solutions (May 2018)

SUGGESTED SOLUTIONS

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 L$211m.
This means that revenue can fall to this level from the expected level of L$232m 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 9% before
we no longer make a profit.
The line ABCDE has a different break-even point to the straight line. Here the break- even position
is where revenue is approximately T$208m. This means that revenue could fall to this from the
expected total of L$232m 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 so low at only 9%. Our c/s ratios are high and
fixed element of cost of sales is not excessive either (as shown by high gross profit margins). The
main problem is that our fixed operating expenses are particularly high.
The graph thus emphasises 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 selling shoulder bags once targets
for sales of tote bags had been achieved.
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
fashion shows, 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).
Simon’s comments
One of the main things to come out of Simon’s graph is that hitting targets for all bag sales is only
just sufficient to cover budgeted fixed costs - point D only just makes a profit. In that respect it
could be argued that we depend heavily on contribution from accessories to make a profit.
I addressed the issue of safety margin above – revenue can fall by 9% before a loss results.

Given this, and the low safety margin, it is reasonable to argue that we need to boost revenue
from bag sales so that we can be profitable based on core product sales alone. However, an
alternative conclusion could be to stress the need to reduce the level of operating expenses, thus
improving the margin of safety and reducing the risk of a loss..

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