Specification topic: Revenue, costs and break- even

Transcription

1 Netherwell Parcels Ltd (Revenue, Costs and break-even Analysis Case Study) Specification topic: Revenue, costs and break- even Case Study: Netherwell Parcels ltd Seeking to capitalise on the continued growth of E- retailing, Jeremy and Mark had set up Netherwell Parcels in Operating initially as a partnership, Netherwell Parcels was originally a Yorkshire based venture. Despite the very competitive nature of the market, they enjoyed pleasing levels of business success. After becoming a limited company and raising funds from selling shares, the business is about to go national, delivering parcels to anywhere on the British mainland. Jeremy, who largely covers the marketing side of the firm, securing new business contracts etc., has calculated the break- even point for the expansion. In a business meeting he explained to Mark and the other shareholders that the total fixed costs, including leasing the vans etc. would be 90,000 per year, based on a quote from their current van provider who they have used since the business first began. The price customers paid to send a parcel depended on size, weight and distance with some customers paying hundreds of pounds to ship particularly heavy and bulky items, though this was unusual. The starting price for sending a parcel was 3.60 and this is the price Jeremy used. Variable costs were largely comprised of wages and fuel. Jeremy used last year s petrol prices to base his calculations on, arriving to the conclusion of 1.25 variable costs per parcel. Jeremy explained that the business would need to ship just under 38,300 parcels to break even. Mark said this figure worried him as it was higher than he had expected and he was not sure the calculation was correct. Other shareholders also expressed concern. Upon reviewing the figures, a member of the board said she felt the vans could be leased for 20,000 less per year by using another company she knew of and this would be the best way to reduce the break- even point. Exam- style questions 1. Assess two reasons why the break- even figure given to Mark could be unreliable (10 marks) 2. Evaluate whether leasing vans from a different supplier would be the best way to lower the break- even point? (20 marks)

2 Netherwell Parcels Ltd (Revenue, Costs and break-even Analysis Case Study) 1. Assess two reasons why the break- even figure given to Mark could be unreliable (10 marks) Jeremy is not the financial director but mainly deals with marketing issues so may not have the experience in completing break- even calculations Petrol prices fluctuate and are based on last year s figures so the variable cost figures are likely to be out of date and inaccurate The price customers pay changes depending on what is being shipped. Jeremy s figure is based on the cheapest price customers pay which is likely to generate a higher break- even point than is correct The fixed cost figure is based on a quote from one firm. The figure could be lower if a variety of quotes were to be gained from different van leasing companies Jeremy has a lack of experience in running a business of this size and may have over or under estimated the number of vans etc. required. Potential counterbalance The extent to which the break- even figure is unreliable depends on a number of factors including how much experience Jeremy has of completing break- even calculations as well as the extent to which petrol prices fluctuate 2. Evaluate whether leasing vans from a different supplier would be the best way to lower the break- even point? (20 marks) This would be a huge saving. If fixed costs fell and other figures remained the same, the new break- even output would be parcels. This is over 8500 parcels less than Jeremy s break- even point The business have used the same company for vans since 2008 perhaps it is time to shop around and get other quotes Potential counterbalance: Other vans may be of lower quality breakdowns could be very costly and competitors will soon take their trade They have built up good relationships and loyalty with their current van supplier and presumably have found they work well (or they would not have continued to use them for so long) Alternative methods may be better e.g. o Increasing the prices charged to customers (though this may be difficult in a competitive market) o Reducing variable costs e.g. wages (unpopular with unions and may demotivate employees) The suitability of this proposal depends on: o The reliability of the alternative van company

3 Netherwell Parcels Ltd (Revenue, Costs and break-even Analysis Case Study) o The background of the shareholder that suggested it it is possible she has a vested interest in the company she is suggesting o How reliable Jeremy s initial figures are perhaps the break- even point is actually far lower than suggested and so steps to reduce it may not be as crucial as it appears

4 Revenue, costs and break-even Q1 Fill in the gaps If a business is breaking even it is neither making a profit nor a. To calculate how many units a business must sell to break- even, they must first calculate their contribution per unit. This equals the minus the. Break- even output is calculated by the following formula: divided by. The higher the firm s, the greater the break- even output will be. refers to the difference in output between the break- even output and the number of units sold. Choose from: contribution per unit, average selling price, margin of safety, loss, variable cost per unit, fixed costs Q2 Calculation time Average selling price: 4 Variable cost per unit: 1.50 Total fixed costs: 50,000 Planned output: 25,000 Using the data above, calculate the following: Contribution per unit Total contribution if planned output is sold Break- even output Margin of safety if planned output is sold

5 Revenue, costs and break-even Q3 The Break- Even Chart Total revenu Costs and Revenues ( ) Total costs Total variable costs 20 Fixed costs Output Use the chart to answer the following questions: 1. What is this firm s price? 2. What is break- even output? 3. What is their margin of safety if six units are sold? 4. What profit/loss will be made if eight units are sold? 5. What percentage of the total costs at 9 units of output are fixed? 6. Imagine fixed costs double. Amend the diagram above and calculate the new break- even output.

6 Revenue, costs and break-even 4 Explain the impact of the following changes on a firm s break- even point 4.1 A shop s rent increases. 4.2 The business lowers its selling price. 4.3 Raw material costs fall. Q5 True or False? 5.1 Break- even output is calculated by fixed costs divided by total contribution. 5.2 The wider range of products and prices a business has, the more useful break- even analysis is. 5.3 If a business has a positive margin of safety, it will make a profit. 5.4 If total contribution is less than the total fixed costs, the business will break- even. 5.5 A rise in selling price will make the total revenue curve steeper.

7 Revenue, costs and break-even - Answers Q1 Fill in the gaps Loss Average selling price Variable cost per unit Fixed costs Contribution per unit Fixed costs Margin of safety Q2 Calculation time Contribution per unit = 2.50 Total contribution = 62,500 Break- even output = 20,000 units Margin of safety if planned output is sold = 5,000 units

8 Revenue, costs and break-even - Answers Q3 The Break- Even Chart 120 Costs and Revenues ( ) Total revenu Total costs 2 Total costs Total variable costs Fixed costs 2 Fixed costs Output 1. What is this firm s price? 100/10 = Break- even output? 4 units 3. What is their margin of safety if six units are sold? Two units 4. What profit/loss will be made if eight units are sold? What percentage of total costs at 9 units of output are fixed? 20/64 x 100 = 31.25% 6. Imagine fixed costs double. Amend the diagram above and calculate the new break- even output. 8 units now must be sold to break even. 4 Explain the impact of the following changes on a firm s break- even point 4.1 A shop s rent increases. This increases fixed costs meaning more units must be sold to pay for the higher fixed costs, increasing the break- even point. 4.2 The business lowers its selling price. This lowers contribution per unit so now the firm must sell more units to pay for the same fixed costs as each unit is contributing less, increasing the break- even point. 4.3 Raw material costs fall. This increases contribution per unit as variable costs have fallen so now the firm must sell fewer units to pay for the fixed costs, reducing the break- even output required.

9 Revenue, costs and break-even - Answers Q5 True or False? 5.1 False (it s divided by contribution per unit) 5.2 False (it is less useful if there are a range of prices) 5.3 True 5.4 False (if total contribution is less than total fixed costs the business will make a loss) 5.5 True