Managerial Accounting Revenue Management 2.3 Flashcards
What are the 4 components to Revenue Management?
- Cost Profit Volume Analysis
- Contribution Margin
- Cost Approaches to Pricing
- Menu engineering
What is Cost Volume Profit (CVP) Analysis?
A set of tools used to determine the revenues required at any desired profit level
Expresses relationships among
- Various costs
- Sales volume
- Profits in graphic or equation form
Graphs and equations assist management in making decisions
What are the Cost-Volume-Profit Analysis : Assumptions?
Cost-Volume-Profit Analysis : Assumptions
- Fixed Costs remain constant during the period being analyzed
- Variable Costs fluctuate in a linear fashion with Revenues
- Variable Costs are constant on a per unit basis
- Productivity remains constant
- Revenues are proportional to Variable Costs
- There are no volume discounts
- All costs can be broken down into their Fixed and Variable components
- Joint Costs are not eliminated when one department is closed
What are the CVP model considerations?
CVP model considers:
- Only quantitative factors
- capable of being measured or expressed in numerical terms
- No qualitative factors
- relating to or involving comparisons based on qualities
What does CVP tell us?
What does it tell us?
- Which products or services to emphasize
- The volume of sales needed to achieve a targeted level of profit
- The amount of revenue required to avoid losses
- Whether to increase fixed costs
- How much to budget for discretionary expenditures
- Whether fixed costs expose the organization to an unacceptable level of risk
What is the formula for CVP?
CVP analysis begins with the basic profit equation
Profit = Total revenue - Total costs
Separating costs into variable and fixed categories, we express profit as:
Profit = Total revenue - Total variable costs - Total fixed costs
What are the CVP Single Product Analysis variables?
CVP Formula for Single Product Analysis
I = Net Income
S = Selling Price
X = Units Sold
V = Variable Costs Per Unit
F = Total Fixed Costs (Plus Profit)
CVP Formula for Single Product Analysis
SX = Total Revenue
VX = Total Variable Costs
What is Break-Even Point?
The break-even point is the point in the volume of activity where the organization’s revenues and expenses are equal
What is the formula for break-even?
Basic Formula for Break-Even (Income Equals 0)
In = SX – VX – F
0 = SX - VX – F
- Break-Even Formula Variations
- Units Sold at Break-Even
X = F / (S - V)
•Fixed Costs at Break-Even
F = SX - VX
•Selling Price at Break-Even
S = (F / X) + V
•Variable Cost Per Unit at Break-Even
V = S - (F / X)
- In = Net Income
- S = Selling Price
- X = Units Sold
- V = Variable Cost Per Unit
- F = Fixed Costs
Calculate Units Sold at break-even?
Example
The Budget Motel, a rooms-only lodging operation, maintains an average selling price per room of $30 and incurs a variable cost per room sold of $10. If the property’s fixed costs are $20,000 for the month, the breakeven point for the month would be:
A. 200 rooms sold B. 500 rooms sold
C. 667 rooms sold D. 1,000 rooms sold
X = Fixed Costs/(Selling Price – Variable Cost Per Unit)
X = 20,000 / ($30 - $10)
X = 20,000 / $20
X = 1,000 rooms to breakeven
What is fixed cost at break-even?
The Sunset Motel’s breakeven point is achieved when 300 rooms are sold each month. Its average daily rate (ADR) is $30, and the variable cost per room sold at $10. Its total monthly fixed costs equal:
A. $30.00
B. $3,000
C. $6,000
D. $9,000
F = SX - VX
Sales Price x Units Sold = $30 x 300 = 9,000
Less:
Var. Cost Per Unit X Units Sold $10 x 300 = 3,000
Fixed Costs = 6,000
What is the selling price at break-even?
The Morton Inn, a 100-room limited service lodging property has variable cost per unit of $22.50 and monthly fixed costs of $102,500. What must ADR be if Morton Inn wants to break even at the end of the 25thd ay of each month? Assume paid occupancy is 75%.
S = (F / X) + V
Sales Price = Fixed Costs + Variable Cost Per Unit
102,500 / [(100 * 25) * .75] + 22.50
Or
102,500 / 1875 = 54.67 +22.50
Sales Price s/b = $77.17
Determine Variable Cost Per Unit at Breakeven
The Morton Inn, a 100-room limited service lodging property monthly fixed costs of $102,500. Rooms Sold are 1,875 at an average rate of $77.17. What are variable costs at breakeven?
Variable = Sales Price – (Fixed Costs / Units Sold)
Sales Price – (Fixed Costs /Units Sold)
$77.17 – (102,500 / 1,875)
$77.17 – 54.67 = $22.50
What is the Contribution Margin?
- The contribution margin is total revenue minus total variable costs
- The contribution margin per unit is the selling price per unit minus the variable cost per unit
- Both contribution margin and contribution margin per unit are valuable tools when considering the effects of volume on profit
- Contribution margin per unit tells us how much revenue from each unit sold can be applied toward fixed costs
- Once enough units have been sold to cover all fixed costs, then the contribution margin per unit from all remaining sales becomes profit
How many ways can you calculate Break-Even?
2 Ways
- Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit
- Contribution Margin Approach
Break-even = Fixed Cost (FC) / (1 – Variable Cost %)
Or
Fixed Costs (FC) / Contribution Margin %
Equation Approach Sample
Contribution Margin Approach Sample
What is Contribution Margin Approach 2?
Contribution Margin Ratio
Contribution Margin Ratio Practice
Contribution Margin Example
The F&B Director of Hotel Premiere has estimated sales of $80,000 for the month of April. His estimated fixed payroll is $30,000, overhead is $8,000 and a food cost of 25%. What is the break-even point in dollars?
Fixed Costs/CM Ratio = Break-Even (In Sales Dollars)
Fixed Costs = Labor + Overhead
Fixed Costs = $30,000 + $8,000 = $38,000
Variable Costs = 25%
Break-even = $38,000/(1-.25) = $50,667
$50,667 is break-even dollars is where there is no loss or profit. Revenues = Fixed + Variable Costs.
__________________________________________
How do we figure in units if Avg Check is $25 for covers(Volume)
Break-even $ / Average check
Break-even Volume = $50,667 / $25 = 2,026.68 or 2,027 covers
__________________________________________
We can determine the number of units that Curl must sell to earn a profit of $100,000 using the contribution margin approach.
(Fixed expenses + Target profit) / Unit contribution margin
(80,000+100000)/200=900 units
Equation Approach Example
The F&B Director of Hotel Premiere has estimated sales of $80,000 for the month of April. His estimated fixed payroll is $30,000, overhead is $8,000 and a food cost of 25%. What is the break-even point in dollars?
(500*X)-(300*X)-80,000 =100,000
(200X)=180,000
X=900 units
What is Safety Margin?
Safety Margin:
The difference between budgeted sales revenue and break-even sales revenue
The amount by which sales can drop before losses begin to be incurred
Safety Margin Sample
Change in Fixed Costs Sample
Curl is currently selling 500 units per year
The owner believes that an increase of $10,000 in the annual advertising budget, would increase sales to 540 units
Should the company increase the advertising budget?
Sales will increase by
$20,000, but net income
decreased by $2,000.
What are the Changes in Unit Contribution Margin
Because of increases in cost of raw materials, Curl’s variable cost per unit has increased from $300 to $310 per unit. With no change in selling price per unit, what will be the new break-even point?
(500*X)-(310*x)-80,000=0
X=422 units
_______________________________________________________
Suppose Curl, Inc. increases the price of each unit to $550. With no change in variable cost per unit, what will be the new break-even point?
(550*X)-(300*x)-80,000=0
X=320 units
CVP Analysis with Multiple Products 1
- For a company with more than one product, sales mix is the relative combination in which a company’s products are sold
- Different products have different selling prices, cost structures, and contribution margins
Let’s assume Curl sells Units of A and Units of B and see how we deal with break-even analysis
Part 1 Solve
CVP Analysis with Multiple Products Part 2
For a company with more than one product, sales mix is the relative combination in which a company’s products are sold
Different products have different selling prices, cost structures, and contribution margins
Let’s assume Curl sells Units of A and Units of B and see how we deal with break-even analysis
CVP Analysis with Multiple Products Part 3
For a company with more than one product, sales mix is the relative combination in which a company’s products are sold
Different products have different selling prices, cost structures, and contribution margins
Let’s assume Curl sells Units of A and Units of B and see how we deal with break-even analysis
What is Weight Contribution Margin?
Weight Contribution Margin = Total Revenue – Total Variable Cost/Total Revenue
Can be used when:
Breakdown of total fixed and variable costs are known
Since the hospitality industries’ products have a different CM, the use of CM Percent (Weighted) is utilized frequently
The Weighted CM Ratio Is computed as follows:
- WCMR = (Total Revenue - Total Variable Costs)/Total Revenue
- Divide the Weighted CMR into the Fixed Costs (and Profit if Applicable) and the result is the Required Sales Level
What is Margin of Safety?
Margin of Safety
- Excess of Budgeted or Actual Sales over Sales at Break-Even
- Expressed in Units or Dollars
What is Sensitivity Analysis?
Sensitivity Analysis
- Study of the sensitivity of dependent variables to changes in independent variables
- Looks at the incremental number of units required to sold to cover additional costs
What is Operating Leverage?
Operating Leverage
- Extent to which expenses are Fixed rather than Variable
- “Highly Leveraged” when Fixed Costs to Variable Costs Ratio is high
- Highly Leveraged means a small increase in sales yields a large profit (above break-even)
What is Elasticity Of Demand?
Basic economic concept states that, all other things staying the same:
- A price increase will reduce the quantity demanded for a product or service
- The question a company must answer is by how much will demand drop if we raise prices?
Provides a means for measuring how sensitive demand is to changes in price
Companies prefer to have inelastic demand for their products and services
- When demand is inelastic price increases will not drive away too many customers
- When demand is elastic raising prices will be counterproductive
- If elasticity exceeds 1 then demand is elastic
- If elasticity is less than 1 it is inelastic
Elastic Demand
Inelastic Demand
Is the Demand Elastic or Inelastic?
A budget hotel sold 1,000 rooms during a 30-day period at $60 per room. The next 30-day period they sold 950 rooms at $66. Is the demand elastic or inelastic?
Elasticity = ((1,000 – 950) /1000) / (66 – 60) / 60
Elasticity = .05 / .1 = .5 Demand is inelastic
Informal Approaches to Pricing
What are the 4 pricing approaches?
- Competitive Pricing: Pricing based on what the competition charges or the leader in the market.
- Intuitive Pricing
- Psychological Pricing
- Trial-and-Error Pricing
All informal approaches fail to consider costs
_____________________________________________________
Factors that Modify Cost Approaches to Pricing
- Prices charged in the past
- Guests’ perceptions of value
- Prices charged by the competition
- Price rounding
What are the steps of Ingredient Mark-Up Approach?
Ingredient Mark-Up Approach
- Determine ingredient costs
- Determine the multiple to use in marking up the ingredient costs
- Based on desired product cost percentage
- Multiply ingredient costs by the multiple to get the desired price
- Determine whether the price seems reasonable based on the market
__________________________________________________________
Multiple = 1/Desired Product Cost %
Ex. If want 40% then multiple is 1 / 0.4 = 2.5
Ingredient Mark Up Example
Prime Ingredient Example
What is the Rooms Pricing Traditional Method?
$1 per $1,000
- Sets price of a room at $1 for each $1,000 of project cost per room
- Fails to consider current value of facilities
- For example if the project cost of a room is $80,000 then the price (average rate) of the room will be: $80000/$1000 or $80
What is the Hubbart Formula?
Hubbart formula
- Bottom-up approach
- Similar approach used for food and beverage
Desired Profits
+ Income Taxes & Interest
+ Management Fees
+ Fixed Costs
+ Undistributed Operating Expenses
+(-) Non-room departmental losses (profits)
+ Direct Expenses of the Rooms Department
_____________________________________
Required Rooms Department Revenue
What is the Hubbart Formula? Solving part 2
Whats the formula for Equivalent Room Occupancy(ERO)?
(Current Occupancy % x Rack Rate – Marginal Cost)/Rack Rate x (1 – Discount % - Marginal Cost)
OR
ERO =(Current Occupancy x Current Contribution Margin) / Revised Contribution Margin
What is ERO for below?
Bruce & Lucy’s, a 100-room lodging operation, which has a rack rate of $100 and a marginal (variable cost) of $20. The Inn currently has a 60% paid occupancy percentage. The manager is considering discounting the rack rate by 20%. What new paid occupancy percentage must be achieved to yield the same amount of room contribution margin from room sales?
Group Room Anlayis
A group would like to stay at your hotel. It is calling six months prior to its needs are as follows:
- Fifty rooms for three nights
- Arrival on Sunday, departure on Wednesday
- Room rate of $100 per room per night
- One large meeting room for 50 people on Monday and Tuesday
- Light food and beverage needs for only morning and afternoon breaks
- $1,000 per day budget for meeting space and food and beverage
Your hotel:
- has 200 rooms
- Is forecasting the following:
- Sunday 50% $125 ADR
- Monday 90% $130 ADR
- Tuesday 95% $127
The meeting rooms is available
What is Menu Engineering?
Menu Engineering
- A Tool to increase Food & Beverage profits
- Smith and Kasavana
- Analyzes Popularity and Contribution Margin (Profitability)
- Two by Two Matrix
- Classified Items As Stars, Dogs, Puzzles, or Plow horses
- Stars = H pop, H$
- Puzzles = L pop, H$
- Plow horses = H pop, L$
- Dogs = L pop, L$
____________________________________________________
- Stars. Both popular and profitable, these items are your best opportunity to build a stronger, more profitable restaurant
- Puzzles. Products that make a higher-than-average profit, but lower-than-average sales, these items may be wrong for your restaurant, may be too high-priced, or may need to be marketed or named differently
- Plow Horses. These items are high-volume with below-average profit. Items that have a high competitive nature will probably fall into this category (particularly items that don’t differentiate your menu from a number of other restaurants, including popular standbys like burgers)
- Dogs. Dogs underperform in both profit and popularity, so if you cut an item, this is often a great place to start
Average Popularity & Item Popularity
•Average Popularity =
(100% / Number of Items) * (70%)
•Item Popularity =
Item is popular if individual item’s sales mix exceeds 70% of the Average Popularity
•Example: 10 Items on the menu
Average Popularity = (100% / 10) * (70%) = 7%
Item Popularity = If individual sales mix is > 7%, Popular
