Read the attached article and summary how Good Food For You company used CVP analysis

PAPER [:1 Management Accounting Fundamentals C'v'P analysis is more than a number-crunching device to obtain simple answers. Grahame Steven shows how it also provides a mechanism for further evaluation. Costholumefprofit [CUP] analysis can be used to determine l'IO'W many products must be sold in order to break even or reach a target profit and also to calculate the margin of safety for a business proposal. Panel 1 contains the formulas for these calculationsilthough the information it provides is extremely useful. CVP analysis can also offer a valuable insight into the business issues that underpin a venture. Good Food for You (GFFY}.which is run by a sole trader. is considering selling freshly cooked venison baguettes at Flock in a Hard Place. an annual twoday heavy metal festival held at the foot of Ben Nevis. Table 2 contains the information obtained by ch'r for the forthcoming festival. To begin the C'lr'P analysis we must determine the break-even point for the proposal ie. the sales gure {in units} that will generate neither a profit nor a loss. The rst step is to classify which costs are fixed and which are variable. Fixed costs are those that aren't affected by activity ie. the number of sales.Variable costs are those that have a linear or close relationship with activity. Although most costs for simple projects can be classified readily in this way, it's not always a straightforward task 'Mth regard to the GFFY propose-L the costs of the festival pitch, accommodation, food and petrol are dearly fixed, because they will be incurred however many baguettes are sold.The average cost per baguette is variable. because it is directly linked to the number of units sold. Costs will increase by 1 every time a baguette is sold.The cost of the gas used for cooking is more problematicaLAlthough the number of baguettes sold will affect gas usage. it's highly unlikely that the gas will be turned on and off each time a baguette is produced. since that would be an inefficient way to operate. So. while gas is not a fixed cost. it should be treated as such for this analysis because it's more fixed than variable in nature. The second step is to calculate the contribution: the money made from the sale of each baguetteThis is the selling price per unit minus the variable cost per unit: 3 1 I E2. The xed costs are then totalled:-[350 a: 2] + 200 1- 120- + 30 1- E300 I 1 ,400.The lost rental income is included in the calculations because it is an opportunity cost ie. it represents money that will not be eamed if the van is used at Rock in a Hard Place. The nal step is to calculate the break-even point by dividing total fixed costs by contribution per unit E1 .400 e E2 I T00. So GFFY has to sell T00 baguettes at the festival to break even. 1 FORMULAS FOR (IIISTii'liI'IlIIILUl'rlEllr PROFIT ANALYSIS I Contribution I selling price per unit variable cost per unit I Break-even sales (units) I fixed costs + contribution per unit I Profft target {unftsj I [fixed costs + profit target] + contribution per unit I Margin of safety {percentage} I {target sales breakeven saleij1l|0 break-even sales 2 INFORMATION FOR GOOD FOOD FOR YOU'S PROPOSED PROJECT AT ROCK INA HARD PLACE Sales price: 3 per baguette. Average cost of each baguette: 1. Cost of pitch: 350 per day. Cost of petrol for van: E120. Cost of gas for cooking: 30. if it is not used at Rock in a Hard Place] NB; it's assumed that food wastage will be negligible, since the mobile kitchen has a freeter compartment and a quirkdefrost facility. Total accommodation and food cost for three nights: 200. Lost rental income on van.- 300. [The van can be rented out to a third party but it needs to do better than thatThe owner's profit target for this project is E500.The number of sales required to achieve this is calculated by adding the prot target to fixed costs and then dividing it by the contribution: [600 + 1,400} + 2 I 1,000. The margin of safety indicates how far sales can deviate from the budget or profit target before a loss is incurred. The margin for this project is: {1,000 T00} + 1,000 I 30 per centAlthough this figure seems reassuring, it depends on the profit target. since an overoptimistic target will produce an unreliable figure. The calculations have produced mo important figures so far: the break-even point and the quantity of sales required to hit the profit target. But what are the operational implications of these figures? A key issue is the length of time the van will be September 2005 Ill-If 51 Paper C1 EXAM NOTICE Visit www.cimaglobal.com regularly for updates. open for business. The owner might decide, November 2005 exam dates Pre-seen material for the based on experience, to operate for 10 hours Tuesday November 22. TOPCIMA case study each day. This assumption can be used in Wednesday November 23 The pre-seen material and assessment calculating the average number of sales that Thursday November 24. matrix will be available to download from must be made every hour to break even over CIMA's website from September 12. the two days. The average hourly sales Exam entry It's your responsibility to download this needed to achieve break-even are: 700 + (10 Enter for the November exams online material and familiarise yourself with it x 2) - 35. at www.cimaglobal.com/examentry from before the exam. A "clean" copy of the Although 35 sales an hour seems possible, August 3. pre-seen material and assessment matrix some periods will be quiet and others will be The standard closing date for entries will be given to you in the exam. You very busy. The owner may consider it to be is September 14. If you enter after this cannot take any notes into the exam hall. achievable, but what about the profit target? date, you will be accepted only as a late The average number of hourly sales required entry and you will have to pay a late Ask a tutor - September event to meet the target is: 1,000 + (10 x 2) - 50, entry fee. The deadline for late entries is Visit CIMA's website to find out about which is far tougher. Although the owner September 21. the next event under the new could reduce the target profit to reduce the qualification. Use this opportunity to average number of sales required, a more Exam fees obtain advice from an experienced tutor. fruitful idea could be to review the You must pay your exam fees and clear assumptions that underpin the calculations any outstanding balance by September 30 . CBA deadline for the CIMA - selling price, variable costs and fixed costs - in order to sit the November exams. Certificate in Business Accounting to see whether there is room for manoeuvre. CIMA reserves the right to withdraw your If you wish to sit managerial level exams The first items to consider are fixed costs. entry and apply an administration charge in November you must complete all of While it's probably not possible to negotiate of E50 should payment not be received your certificate level subjects via a lower price for the festival pitch or to by this date. Managerial level papers cost computer-based assessment (CBA) by reduce the van's petrol and gas consumption, E55 per subject, strategic level papers cost September 1. Visit www.cimaglobal.com/ the accommodation cost will be reduced by E60 per subject and TOPCIMA costs E80. certificateentry for full information on 140 if the owner stays at the camp site The late entry fee is f160. entering for a certificate level CBA. instead of a guest house for the three nights. Please read the rules of exam entry for The owner may be reluctant to change the further information. CIMA Professional Development selling price, since it has been set in relation Certificate in Business Taxation to the expected prices of competing caterers. November 2005 exam results if you have passed intermediate level paper Using lower-quality venison and bread would Results will be communicated to students 6 Financial Accounting, but not paper 5 reduce the variable cost. The owner may in the last week of January 2006. Business Taxation (under the old syllabus), choose this course of action because most you can use a pass in the computer-based potential customers at a heavy metal festival Cancellations and changes assessment Introduction to Business are unlikely to be gourmets. It would reduce We do not accept cancellations and Taxation (UK) to gain credit for managerial the variable cost per unit from $1 to 10.75. will not refund entry fees. level paper P7, Financial Accounting and The two identified savings would reduce To change papers or exam centres Tax Principles. Visit www.cimaglobal.com/ fixed costs by f140 to f1,260 and increase you must e-mail cima.contact@ certificateinbusinesstax for more details, the contribution per unit by 60.25 to $2.25. cimaglobal.com and pay the the full syllabus and sample questions. All this produces a revised average hourly administration fees by September 30. break-even baguette sales figure of: Changes made before September 14 Queries (E1,260 + (2.25) + 20 = 28. The number of will cost E25. Changes made between Visit www.cimaglobal.com or get in touch hourly sales required to hit the profit target September 15 and 30 will cost $50. with CIMA Contact or your local office. FM would be: ($1,860 + 2.25) + 20 = 41.3. The owner would then either proceed on this basis or consider other courses of action NOMINATE that could make the proposal more viable. FM YOUR The institute is seeking nominations for the CIMA Financial Management Awards 2005 and would welcome submissions from students for the tutor of the year category. If your tutor is innovative, enthusiastic and gets great results, why not Grahame Steven is a lecturer at Napier TUTOR put them forward? Visit www.cimaglobal.com/awards2005 for further details. University, Edinburgh. OF THE YEAR FINANCIAL 52 MANAGEMENT September 2005