Notes and various examples on marginal costing, the change in total prodction cost when making an additional unit, including margin of safety, target profit and break-even point
Unit 6 – Marginal Costing
Margin of Safety
The margin of safety is the difference between the expected level of sales and the
breakeven point, managers use this in order to know how far sales can fall before the
business becomes unprofitable.
A business sells one type of vase for £20
Variable Costs are £5 per vase
Fixed Costs are £2,400 per month
E.G. if a business has a breakeven point of 80 and they budget to sell 170 vases a month,
then what would their margin of safety be? It can be calculated in sales units or sales
revenue
Budgeted Sales−BE Sales
¿
Budgeted Sales
MOS (in units) = 170 – 80 = 90 units or 90/170 = 52.9%
MOS (in £ if they sell for £20 each) = (3,400-1,600)/3,400=52.9%
This indicates that the business’ sales could fall by 52.9% from their budgeted level before
profit becomes loss
Target Profit
Target profit is the amount of profit a business expects to make within a designated
accounting period. Contribution analysis can be used as a way of calculating the level of
sales needed in order to earn a required level of profit
¿ Costs +Target Profit
Contribution per Unit
Using the vase manufacturer, the expected profit if they sell a budgeted amount of 200
vases
(Production x Contribution per Unit) - Fixed Costs
(200 x 15) - £2,400 = £600
Meaning that this vase manufacture would expect to make £600 profit when they sell 200
units
How many units would they need to sell to make £3,000 profit
(£2,400 + £3,000) / £15 = 360
Meaning that this vase manufacture would need to sell 360 units of vases in order to make
£3,000 profit
, Example
Star Track Ltd. Manufactures only a single product, games consoles, with an estimated sales
turnover of £7,000,000 per annum.
Selling Price per Unit = £100
Materials per Unit = £21
Labour per Unit = 1hr @ £5 per hr (Skilled)
3hrs @ £3 per hr (Unskilled)
Variable overhead = £20
Fixed Overhead = £1,800,000
Break even point (in units) = £1,800, = 40,000 Units
Break even point in sales value = 40,000 units X 100 = £4,000,000
£ £
Selling Price per Unit 100
Variable Costs:
Materials 21
Labour – Skilled 5
Labour – Unskilled 9
Overheads 20
Total Variable Costs 55
Contribution per Unit 45
Margin of Safety (in units) = (70,000 units – 40,000 units) / 70,000 units = 42.86%
Margin of Safety (in sales value) = (£7,000,000 - £400,000) / £7,000,000 = 42.86%
Expected Profit = (70,000 x £45) - £1,800,000 = £1,350,000
Target Profit (£2,000,000) = (£1,800,000 + £2,000,000) / 45 = 84,444 units
Disadvantages of using Break Even Analysis
It assumes a linear relationship, that all revenues and costs are a straight line on a graph,
however in this is unlikely to be the case in reality, though the distortions may not be
material.
Stepped fixed costs, fixed costs are likely to increase when there are large changes in
production levels.
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