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Finance and accounting 2Chapter 11: Cost structure
Reporting
Internal; financial information to a company’s management
External; financial information to other stakeholders
Fixed and variable costs
Fixed costs do not change in relation to the output level.
Variable costs change in relation to the output level.
Cost behaviour when output level increases
Total costs Unit costs
Fixed costs Remains equal Decreases
Proportionally variable costs Increases Remains equal
Variable costs can be:
Linear (proportionate) if the production increase, costs increase in the same proportion
and unit costs remain unchanged; e.g. basic raw material.
Progressive if the production increase, costs increase more quickly and unit costs
increase; e.g. premiums for shifts or overtimes.
Degressive if the production increase, costs increase more slowly and unit costs
decrease; e.g. material costs when buying in bulk.
Analysing the behaviour of variable cost
Production units Variable cost in euro’s Variable cost per unit
2.000 5.000 (5.000/2.000) 2,50
4.000 9.000 (9.000/4.000) 2,25
6.000 12.000 (12.000/6.000) 2,00
,The variable cost per unit declines, this is called degressive variable costs.
Total costs = fixed costs + variable costs
Total costs = fixed cost + amount of units x variable cost per unit
F = Fixed cost
v = variable cost per unit
q = amount
Total variable cost = q x v
Total cost = F + q x v
Contribution margin
Contribution margin = turnover – (total) variable cost (of turnover/sale)
Selling price = €10 per unit
Variable cost per unit = €4
Contribution margin = €6 per unit
The contribution margin must be so high that:
1. All the fixed cost are paid for
2. Profit is made
Contribution margin per unit = p – v
Break-even analysis
Costs and sales revenue should be “in balance”
Break-even quantity = fixed costs / (selling price per unit – variable unit costs)
The contribution margin per unit (p - v) has to be earned q times to cover the fixed costs (f).
Each additional contribution margin earned is profit.
Break-even method: Profit and costs being equal. You can calculate how many products you
need to sell in order to generate profit.
Let’s say I want to generate a profit of €4000. I add the €4000 to the fixed costs in the break-
even formula. Then I calculated how many units I need to sell in order to earn €4000 profit.
, Contribution margin as a percentage
The contribution margin is there to cover the Fixed cost and to make profit.
There are various ways to express the contribution margin :
1. contribution margin per product = (p – v)
2. contribution margin per period = (turnover – Total variable cost per period)
3. contribution margin as percentage of the sale price or of the turnover (%)
De contribution margin as percentage is in essence a ratio: how much, in percent, of the sale
value of a product is retained.
Expressed in percentage, so in relation to something, i.e. the sales price or turnover.
Example:
Revenue: €100,000 = 100%
Total variable cost: €30,000 = 30%
Contribution margin: €70,000 = 70%
Fixed costs: €49,000
Break-even revenue = €49,% = €70,000
Break-even-turnover calculation
1. BE turnover = quantity x p
F
2. BE turnover = ----------
contribution%
contribution% = % of the turnover to cover the fixed costs (and profit)
Turnover single product and expected profit
You can derive the turnover using the following formula in case of many different products:
Turnover = (F + profit) / (100% – x%) whereby x% = % of turnover
Or
Break-even turnover = F / contribution margin%
Safety margin
The safety margin represents the percentage by which the revenue can decrease before the
break-even point is reached.
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