8. Short Term Decisions

Question 1

Break even is

Answer 1

The point at which neither a profit nor a loss is made

Question 2

Break even formula

Answer 2

£ Fixed costs / £ Contribution per unit = number of units to break even.

Question 3

In order to use break even analysis we need …

Answer 3

Selling price (per unit)
Costs of Product (var costs p/u & overhead costs, split fixed/var)
Limitations (max production capacity, max sales)

Question 4

The margin of safety is…

Answer 4

...the amount by which sales exceed the break even point.
Can be :
Units
Amount £
%

Question 5

Break even ; target profit

Answer 5

Just take the break even formula:

£ Fixed costs / £ contribution per unit = no. of units

… and add in the desired profit

£ Fixed costs (+ £ Target profit) / £ contribution per unit = no. of units

Question 6

Break even : Profit Volume analysis

Answer 6

Contribution £
_______________ = profit volume ratio

Selling price £

Question 7

Limiting factors are…

Answer 7

Those aspects of a business which restrict output.

Availability of materials
Availability of skilled labour
Availability of machine hours
Finance
Quantity of output which can be sold (market demand for the product)

Question 8

Where there is no limiting factor a business should…

Answer 8

Concentrate on making/selling the product with the highest PVR.

When there IS a limiting factor the business should …

Switch production to the product which gives the highest contribution from each unit of the limiting factor. (Eg contribution per direct labour hour)

Question 9

The key to dealing with limiting factors is…

Answer 9

Maximise the contribution per unit (SP-VC) of limiting factor.

Eg. Contribution per unit / no. direct labour hours if these are limited.

Instead of

Contribution per unit / Selling price per unit.

Ie. If you are short of something make best use of what you have.

Where there is a maximum level of output for that product , make the maximum and then go to the next best

Question 10

PV ratio (profit-volume ratio)
Same as 
CS ratio (contribution-sales ratio)

Answer 10

£ Contribution
-—————— = PV (pro-vol) ratio or CS (contrib-sales) ratio.
£ Selling price

Question 11

Report for MD (recommendations where there is a Limiting factor)

Answer 11

1. Calculate the Contribution per unit of limiting factor to make the decision.
2. Prepare the SPL using the number of units of output (not the number of units of limiting factor)
3. Where there is a max output for the selected product, spill over any unused limiting factor into production of next best product.

Remember to point out that fewer products causes a shortfall in the market. It may be difficult to re-establish these products after the limiting factor has been resolved.

Question 12

‘Special Order’ pricing

Answer 12

Where a business uses spare capacity to make extra sales of its product at a lower price than its normal selling price.

Question 13

Special order pricing is normally used …

Answer 13

When business is profitable at current level of output (ie reached break-even)

Additional sales at ‘special order’ prices can be made at a selling price above marginal cost but below absorption cost.

In this way profits can be increased provided that the additional sales are spare capacity. (I think this means no increase in overheads)

The key to increasing profit from additional sales is to ensure that a contribution to profit is made from the special order.

Question 14

The principles of marginal costing can also be used to establish the effect of changes in costs and revenues on the profit of the biz.

Answer 14

Best way to show changes is a columnar layout showing costs and revs as at present and then proposed changes.

Question 15

Points to remember if using marginal costing principles to make short term decisions…

Answer 15

1. Fixed period costs must be covered. (A balance needs struck)
2. Separate markets for marginal cost (eg abroad)
3. Effect on customers. If using to attract new customers hard to up price
4. Problems of product launch on marginal cost basis.
5. Special edition products (use marginal costing techniques to sell off old model before launching new.)

Question 16

Short term decisions are those…

Answer 16

…which affect the costs and revenues over the next few weeks and months.

Question 17

Break even analysis distinguishes between fixed period costs and variable product costs.

Answer 17

.

Question 18

Relevant costs

Answer 18

Those costs that are changed by a decision

Question 19

Irrelevant costs

Answer 19

Those costs that are not affected by a decision.

Question 20

Sunk costs

Answer 20

Past costs which are irrelevant to decision making

Question 21

Cost; Volume; Profit (CVP)

Answer 21

Analysis of the costs of output, the volume of output, and the profit made.

Question 22

Margin of safety

Answer 22

Current output - breakeven output
——————————————- X 100
Current output

Question 23

Breakeven either

Answer 23

£ Fixed costs/ £ contribution p/u = BE units

£ Fixed costs/ PV (or CS) ratio = BE £rev

£ contribution p/u = £sell - £var costs
PV ratio = £cont/£sell

Not sure where use PV since top method seems simpler and can just multiply units by £sell to get the £rev if needed.

Question 24

Remember ‘demand’ is also a limiting factor

Answer 24

.

Question 25

Normally you look at CS ratio to determine best product.
BUT
Where there is a limiting factor ..
Maximise the contribution per unit of the limiting factor.

Answer 25

To ‘rank’ the products…

£contribution
—————— = £contrib per limiting factor
Qty of LF req.

Question 26

In situation where there’s no limiting factor Don’t make mistake of just looking at £contribution per unit to see which is better product to make… it needs to be CS ratio:

£contrib
———- = CS ratio
£sell

Answer 26

.

Question 27

Marginal costing principles are used in short-term decision-making for…

Answer 27

Break-even
Limiting factors
And ‘special order’ pricing