Assignment 1: Budgeting and Balanced Scorecard

Running head: COST, VOLUME, PROFIT ANALYSIS 1

COST, VOLUME, PROFIT ANALYSIS 5

Cost, Volume, Profit Analysis

Author’s Name

Institutional Affiliation

Cost, Volume, Profit Analysis

Fixed manufacturing costs are those overhead costs that can be specifically associated with a production area of manufacturing goods (Stout et a., 2016). This set of costs are not affected by change of activity hence do not vary. Therefore, for a company to make profits, the management should always be aware of the amounts of fixed manufacturing costs incurred by the company in order to yield enough contribution margin amounts from sale of services or products so as to offset the fixed manufacturing costs. Some of the fixed manufacturing costs that are involved in manufacturing company include utilities, normal scrap, compensation of quality assurance staff, Salaries for production supervisors, factory rent, compensation of material managers, production equipment depreciation and various classes of insurance on facilities, inventory and production equipment.

On the other hand, variable manufacturing costs are those overhead costs that change with activity levels or output of production (Stout et a., 2016). This concept is very essential in modelling the levels of future expenditures of the company as well as determining the minimum possible price for selling a unit of a product. Compared to fixed overheads, variable overheads seem to be smaller. Some of the variable manufacturing costs associated with the production include costs of production supplies, wages for material handling costs of equipment utilities.

Contribution margin is the selling price of a unit product minus all the variable costs associated which results in the profits generated from the sale of each unit (Motta, 2004). Total contribution margin generated by the company represents all the earnings that will be used in payment of fixed costs or expenses as well as generating the company’s profits. It is one of the major concepts that build up the breakeven analysis.

In calculating the ratio of contribution margin that will be used to represent the numerator in the calculations that precede, al the variable costs involved are subtracted from the sales revenue. The result is the contribution margin as illustrated in the following accounting format example:

Produces & Sell 8000 units @20, Variable manufacturing costs @10, Fixed manufacturing costs (Max 10,000units) $38000.

Revenue $160000

Variable Expenses (80000)

Contribution Margin $80000

Fixed Expenses (38000)

Net Profit/Loss $42000

Contribution margin can be used in making various decisions. Some of these decisions include product pricing, increasing or decreasing component costs, acceptance of special orders and incurring additional advertising expense. While making pricing decisions, it is important to note that with the amount of units constant, an increase in price per unit results to an increase in contribution margin and a decrease in price leads a reduction in the contribution margin (Paul et al., 2010). With the above example, what would happen if the price per unit is increased to @25 or reduced to @ 15?

@15 @25

Revenue $120000 $200000

Variable Expenses (80000) (80000)

Contribution Margin $40000 $120000

Fixed Expenses (38000) (38000)

Net Profit/Loss $2000 $82000

The company would rather increase the prices that lower them.

Component costs are fixed costs and a rise in fixed costs increases the overall costs. This would cause a reduction on the earnings of the company in case of a low contribution margin. As well, a reduction in component cost reduces the overall costs hence less affecting the contribution margin.

In a decision to incur additional advertising expenses, there are two things involved. One, it would cost an increase in the variable costs and two, it must impact in an increased number of units sold in order for it to be profitable. However, increasing the advertisement expense per unit product would increase variable expenses which in turn will lower the ratio of the contribution margin. For example, assume increasing the advertising expense by $5000 will increase sales to 9000 units.

Constant +$5000

Revenue $160000 $180000

Variable Expenses (80000) (80000+5000)

Contribution Margin $80000 $95000

Fixed Expenses (38000) (38000)

Net Profit/Loss $42000 $57000

The company should therefore increase the advertisement expense.

For the company to accept special orders, the company should be operating below its maximum capacity which gives a capacity to service the special order. In this case, the additional sales should be more than the additional variable costs. In the case where there is no excess capacity, the cost under consideration should cater for the contribution margin lost in sacrifice of regular sales so as to complete the special order. With reference to the previous example, what would happen if a customer placed a special order of 1500 units @ 15 and the customer will cater for the delivery costs of the product. The company should take the offer.

Revenue $ 182500

Variable Expenses (80000)

Contribution Margin $ 102500

Fixed Expenses (38000)

Net Profit / Loss $ 64500

References

Motta, M. (2004). Competition Policy: Theory and Practice. Cambridge . pp. 102-120.

Paul, WF, Neil, TB, Philip, EP, David, JR (2010). Marketing Metrics: The Definitive

Guide to Measuring Marketing Performance.  Upper Saddle River, New Jersey: Pearson

Education, Inc.

Stout, D., Edward, B., Juras, EP & Cockins, G. (2016). Cost Management – A Strategic

Emphasis  (7th Ed.). McGraw-Hill.

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