Effects Of Price And Variable Cost Changes On Net Profit And Break-Even Point In Business Management
Part 1:
The original scenario also can be referred to as the normal scenario of the organization is presented below. The sensitivity analysis shall be conducted by making necessary changes to the base case scenario.
|
Assumptions under normal circumstances |
|
|
Details |
(?) |
|
Original selling price per unit |
10 |
|
Expected units to be sold originally |
120000 units |
|
Variable cost per unit of finished goods |
2.5 |
|
Fixed expenditure (costs) |
660,000 |
As per the above assumptions the marginal costing statement of the entity is presented in a tabular format below.
|
Details |
Per unit (?) |
Annual (?) |
|
Revenue from sales (120000 x 10) |
10.00 |
1,200,000.00 |
|
Less: Variable costs (120,000 x 2.5) |
2.50 |
300,000.00 |
|
(A): Contributions |
7.50 |
900,000.00 |
|
(B): Fixed costs Per unit fixed cost: (660000 / 120000) |
5.50 |
660,000.00 |
|
Net profit (A-B) |
2.00 |
240,000.00 |
Increase in selling price per unit by 15% from the original selling price. The marginal costing statement of the company will look as following with the revised selling price.
|
Details |
Per unit (?) |
Annual (?) |
|
Revenue from sales (120000 x 11.50) |
11.50 |
1,380,000.00 |
|
Less: Variable costs |
2.50 |
300,000.00 |
|
(A): Contributions |
9.00 |
1,080,000.00 |
|
(B): Fixed costs Per unit: (660000 / 120000) |
5.50 |
660,000.00 |
|
Net profit (A-B) |
3.50 |
420,000.00 |
The net profit of the entity is going to increase significantly with the increase in selling price by merely 15%. This shows that the entity’s marginal costing statement is very sensitive to the changes in assumptions (Grant, 2016).
Marginal costing statement of the organization with reduction in original selling price by 15% is presented below.
|
Details |
Per unit (?) |
Annual (?) |
|
Revenue from sales (120000 x 8.50) |
8.50 |
1,020,000.00 |
|
Less: Variable costs (120000 x 2.5) |
2.50 |
300,000.00 |
|
(A): Contributions |
6.00 |
720,000.00 |
|
(B): Fixed costs Per unit: (660000 / 120000) |
5.50 |
660,000.00 |
|
Net profit (A-B) |
0.50 |
60,000.00 |
The net profit of the entity will decline dramatically with the reduction in original selling price of ?10.00 by 15%. The expected net profit of ?240,000 will declined by 75% to ?60,000 only with mere reduction of 15% in selling price per unit (Adrian and Liang, 2016).
In order to assess the impact of changes in variable cost of production the marginal costing statement has been prepared below.
|
Details |
Per unit (?) |
Annual (?) |
|
Sales (120000 x 10) |
10.00 |
1,200,000.00 |
|
Less: Variable costs |
2.00 |
240,000.00 |
|
(A): Contributions |
8.00 |
960,000.00 |
|
(B): Fixed costs Per unit: (660000 / 120000) |
5.50 |
660,000.00 |
|
Net profit (A-B) |
2.50 |
300,000.00 |
As can be seen in the table above that reduction in variable cost per unit will increase the net profit of the company significantly. The net expected profit is expected to be increased by ?60,000 to ?300,000 with the reduction in variable costs (Valickova, Havranek and Horvath, 2015).
With 30% of selling price assumed to be variable costs instead of original estimation of 25% the net profit of the entity is calculated in the marginal costing statement below.
|
Details |
Per unit (?) |
Annual (?) |
|
Sales (120000 x 10) |
10.00 |
1,200,000.00 |
|
Less: Variable costs |
3.00 |
360,000.00 |
|
(A): Contributions |
7.00 |
840,000.00 |
|
(B): Fixed costs Per unit: (660000 / 120000) |
5.50 |
660,000.00 |
|
Net profit (A-B) |
1.50 |
180,000.00 |
Thus, net profit will reduce by ?60,000 with 5% increase in variable costs. The net profit under revised variable cost of ?3 per unit is expected to be ?180,000 as is visible in the above calculation (Harrison and Lock, 2017).
|
Original circumstances and conditions |
|
|
PV ratio |
75% |
|
(Contributions x 100/ Sales revenue) |
|
|
BEP in sales (Fixed costs /PV ratio) |
|
|
Fixed costs |
660,000 |
|
PV ratio |
75% |
|
Break Even Point sales |
880,000 |
|
BEP in units (Fixed costs / Contribution per unit) |
|
|
Break Even Point units |
88,000 |
|
Contribution per unit |
7.5 |
The break-even sales as per the above conditions is ?880,000 with the company requiring to sale 88,000 units to reach the break-even point.
|
Original selling price increased by 15% |
|
|
PV ratio |
78.26% |
|
(Contribution x 100/ Sales) |
|
|
Break Even Point in sales (Fixed costs /PV ratio) |
|
|
Fixed costs |
660,000.00 |
|
PV ratio |
78.26% |
|
Break Even Point sales |
843,341.00 |
|
Break Even Point in units (Fixed costs / Contribution per unit) |
|
|
Break Even Point in units |
73,334.00 |
|
Contribution per unit |
9.00 |
|
Fixed costs |
660,000.00 |
The break-even sales as per the above conditions is ?843,341 with the company requiring to sale 73,334 units to reach the break-even point in case the sale price is increased by 15% from the original selling price.
|
Original selling price decreased by 15% |
|
|
PV ratio |
70.59% |
|
(Contributions x 100/ Sales) |
|
|
Break Even Point in sales (Fixed costs /PV ratio) |
|
|
Fixed costs |
660,000.00 |
|
PV ratio |
70.59% |
|
Break Even Point sales |
935,000.00 |
|
Break Even Point in units (Fixed costs / Contribution per unit) |
|
|
Break Even Point in units |
110,000.00 |
|
Contribution per unit |
6.00 |
|
Fixed costs |
660,000.00 |
The break-even sales as per the above conditions is ?935,000 with the company requiring to sale 110,000 units to reach the break-even point in case the sale price is decreased by 15% from the original selling price.
|
Variable cost reduces to 20% of selling price |
|
|
PV ratio |
80.00% |
|
(Contributions x 100/ Sales) |
|
|
Break Even Point in sales (Fixed costs /PV ratio) |
|
|
Fixed costs |
660,000.00 |
|
PV ratio |
80.00% |
|
Break Even Point sales |
825,000.00 |
|
Break Even Point in units (Fixed costs / Contribution per unit) |
|
|
BEP units |
82,500.00 |
|
Contribution per unit |
10.00 |
|
Fixed costs |
660,000.00 |
Part 2:
The break-even sales as per the above conditions is ?825,000 with the company requiring to sale 82,500 units to reach the break-even point in case the variable costs decreases to 20% of original selling price instead of 25% of original selling price.
|
Variable costs increased to 30% of selling price |
|
|
PV ratio |
70.00% |
|
(Contributions x 100/ Sales) |
|
|
Break Even Point sales (Fixed costs /PV ratio) |
|
|
Fixed costs |
660,000.00 |
|
PV ratio |
70.00% |
|
Break Even Point sales |
942,860.00 |
|
Break Even Point in units (Fixed costs / Contribution per unit) |
|
|
BEP units |
94,286.00 |
|
Contribution per unit |
7.00 |
|
Fixed costs |
660,000.00 |
The break-even sales as per the above conditions is ?942,860 with the company requiring to sale 94,286 units to reach the break-even point in case the variable costs increases to 30% of original selling price instead of 25% of original selling price.
Margin of safety (MOS): Margin of sales is calculated by deducting the break even sales of an organization from expected sales of the organization.
|
Original circumstances and conditions |
|
|
MOS (Sales – Break even sales) |
320,000.00 |
|
MOS in % (sales – Break even sales) x100/ Sales |
26.67% (Renz, 2016) |
|
Original selling price increased by 15% |
|
|
MOS (sales – Break even sales) |
536,659.00 |
|
MOS % (sales – Break even sales) x100/ Sales |
38.89% |
|
Original selling price decreased by 15% |
|
|
MOS (sales – Break even sales) |
85,000.00 |
|
MOS % (sales – Break even sales) x100/ Sales |
8.33% |
|
Variable costs increased to 30% of selling price |
|
|
MOS (sales – Break even sales) |
257,140.00 |
|
MOS % (sales – Break even sales) x100/ Sales |
21.43% |
Net profit of the entity has changed under different variables. In order to assess how the net profit ratio of the entity has changed with changes in underlying assumptions the net profit ratios have been calculated by using the following formula under different circumstances in the table below.
Net profit x 100/ Sales
|
Net profit ratio (%) |
|
|
Circumstances |
Net profit ratio (%) |
|
Net profit under original circumstances |
20.00 |
|
Net profit if original selling price increases by 15% |
30.43 |
|
Net profit is original selling price decreases by 15% |
5.88 |
|
Net profit if variable costs decreases to 20%. |
25.00 |
|
Net profit if variable cost increases to 30% |
15.00 |
It is obvious from the over calculations that even scarcest of changes within the basic factors such as offering cost and variable costs would altogether impact the amount of benefit of the organization. With the initial offering cost of ?10 per unit and variable costs of ?2.50 per unit the organization is anticipated to gain net benefit of ?240,000 (Karadag, 2015).
In this way, a 15% increase in offering cost would offer assistance the company to extend its net benefit by as much as 75%. In this way, net benefit of the company is exceptionally delicate to the offering cost of each unit of generation. Similarly diminish in offering cost by 15% to ?8.50 per unit would decrease the net benefit of the company from ?240,000 to ?60,000. Subsequently, the net benefit of the company would reduce by 75% consequent to decrease of offering cost by 15% from the initial offering cost of ?10.00 per unit (Bennett and James, 2017).
In any case, slight diminish in variable costs to 20% of unique offering cost would increment the net benefit of the company to ?300,000. Usually an increment of ?60,000 in net benefit which is an increment of 25% from unique net benefit as per the base case. Additionally the increment in variable taken a toll by 5% from 25% of unique offering cost to 30% of unique offering cost would result in diminish in net profit by 25%. Subsequently, the administration must take steps carefully to guarantee that the company is in a position to extend its net benefit within the future by making strides its monetary execution (Bryce, 2017).
Part 3:
Operational use is calculated by partitioning the rate of alter in net benefit of an organization with the rate of alter in deals of the organization. It makes a difference to survey the working use of the organization (Morden, 2016).
Operational utilize is calculated by apportioning the rate of modify in net good thing about an organization with the rate of change in bargains of the organization. It makes a contrast to study the working utilize of the organization.
Rate of alter in deals due to extend in offering cost is calculated underneath:
(1,380,000 – 1,200,000) x 100/ 1200000 = 15%
Calculation of rate of alter in net benefit of the company due to the increment in offering cost is given underneath:
(420,000 – 240,000) x 100/240000 = 75%.
Hence, working use would be as taking after:
Change in rate of net benefit / Alter in rate of deals. = 75% /15% = 5. In this way, the company encompasses a gigantic working use. This demonstrates that for each ? increment in offering cost the working benefit of the company would increment by ?5 expecting other conditions stay unaltered (Brigham et. al. 2016).
Once more with diminish in offering cost of the company would so also influence the net benefit of the company. The taking after calculation would be supportive to get it the effect on net benefit of the company due to diminish within the offering cost of the company.
In case the offering cost diminishes by 15% at that point the working use would be as taking after: Percentage of alter in deals due to diminish in offering cost is calculated below:
(1,020,000 – 1,200,000) x 100/ 1,200,000 = (15%).
Calculation of rate of alter in net benefit of the company due to the increment in offering cost is given below:
(60000 – 240000) x 100/240000 = (75%).
The working use would be as following:
Alter in rate of net benefit / Alter in rate of deals. = (75%) / (15%) = 5. Subsequently, this demonstrates diminish of ?5 for each ? diminish in net offering cost of unit sold by the company on the off chance that other conditions stay unchanged (Zietlow et. al. 2018).
As per the talk over it has as of now seen how the changes in basic conditions of the company changes the productivity of the company. with unique offering cost of ?10 per unit and variable fetched of ?2.50 per unit with add up to settled costs of ?660,000 is anticipated to gain a net benefit of ?240,000. In any case, increment in net offering cost by 15% would increment the net benefit of the company by 75% to ?420,000 i.e. additionally diminish in net offering cost by 15% would decrease the net benefit of the company by comparable edge ?180,000 (Lehmann, 2016).
Original circumstances and conditions
Be that as it may, it is vital to note that changes within the fundamental conditions have been considered one at a time. In this way, in situation testing a brief calculation will offer assistance to survey the effect on net benefit of the company in case there’s more than one changes within the basic factors at a time (Dutra et. al. 2015).
Assume that together with increment in net offering cost the anticipated deals of the company would diminish in extent to the increment in net offering cost. At that point the effect on net benefit of the company is calculated below.
Hence, indeed in the event that the increment in net offering cost comes about in diminish in proportionate deals units indeed at that point the company would be able to extend higher benefit than beneath base case situation (Nwogugu, 2015). Similarly in case diminish in net offering costs would increment the deals unit proportionately at that point the effect on net benefit of the company is calculated underneath (Kerzner and Kerzner, 2017).
As can be seen that the net benefit of the company would diminish with diminish in net offering cost of the company be that as it may, diminish would be altogether less as compared to the situation where no increment in offering units is anticipated from diminish in net offering cost (Lavoie, Rochon and Seccareccia, 2015).
The marginal costing statement prepared at the beginning as well as the different calculations made with different underlying variables showed that the net profit, break even sales, margin of safety and all other important parameters to take important management decisions are quite sensitive to the changes in the underlying conditions. The reason sensitivity analysis is conducted by the management is to evaluate the impact of different circumstances on the operating and financial performance of an organization. It is especially important since a business organization operates in a complex and uncertain environment. Such sensitivity analysis helps the management to take important business decisions in the future and to be prepared for uncertain future.
The dialog almost the anticipated money related exhibitions of the company with the diverse fundamental presumptions appears that the affectability examination on the budgetary execution of an organization gives the administration with critical sum of data as to the anticipated monetary execution of the company beneath distinctive circumstances.
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