Question 1

Shansha Limited has incurred a loss in 2020. Following is the profit and loss account for the company;

(Rupees)
Sales 800,000
Less Cost of Goods Sold (650,000)
Operating Expenses (250,000)
Profit before tax (100,000)
Tax @ 30% 0
Net Profit after tax (100,000)

Other information
1. 40% of cost of goods sold is fixed
2. 25% of operating cost is variable

Next year the company wishes to earn an after tax profit of Rs 175,000

Required
Calculate the sales required to achieve the target profit

Solution

Sales 800,000
FC VC
Cost of Goods Sold (260,000) (390,000)
Operating Cost (187,500) (62,500) (452,500)
Contribution Margin 347,500
CM % 43.438%

Fixed Cost 447,500

Target Profit 250,000 175,000/70%
CM Required 697,500
CM Ratio 43.44%
Break Even (Rs) 1,605,755

Proof

Sales 1,605,755
VC (56.56%) (908,255)
CM 697,500
Fixed Cost (447,500)
Profit before tax 250,000
Tax @ 30% (75,000)
PAT 175,000
Question 2
Suleman Limited is considering to change the pricing strategy for its only
product "Digitech". Details of the last year results and next year projections are
as under:
2021
Sales 2,500,000
Cost of Goods Sold (1,450,000)
Operating cost (975,000)
PBIT 75,000
Interest (105,000)
PBT (30,000)
Tax @ 40% -
Net Loss (30,000)

Other Information
2. 60% of cost of goods sold and 55% of operating costs are variable.
3. All other costs are fixed

Strategy for next year

1. Selling price to reduce by 10% which would increase the volume by 36%
2. All variable costs would reduce by 10% per unit
3. Fixed cost related to COGS will increase by 16% where as the Fixed operating cost
will increase by 12%. Interest Expense will increase by 5%.

Required
a) Calculate the sales required to achieve a target profit of 250,000.
b) Calculate whether the company would achieve the target profit in the above case

Solution

We know that if selling price and variable cost change by same % CM ratio does
not change. So CM ratio for 2021 will also be applicable for 2022

Cost breakup
VC FC Total
COGS (870,000) (580,000) (1,450,000)
Operating Cost (536,250) (438,750) (975,000)
Interest (105,000) (105,000)
(1,406,250) (1,123,750) (2,530,000)

Sales for 2021 2,500,000

Variable Cost 2021 (1,406,250)
CM for 2021 1,093,750
CM Ratio 43.750%
Fixed Costs 2021 2022
COGS (580,000) x1.16 (672,800)
Operating Cost (438,750) x1.12 (491,400)
Interest (105,000) x1.05 (110,250)
Fixed Cost for 2022 (1,274,450)

Target Profit - After Tax 250,000

Target Profit - Before Tax 416,667

Sales required to achieve target profit

Fixed Costs 1,274,450

Profit before tax 416,667
CM to be generated 1,691,117
CM Ratio 43.75%
Sales required 3,865,410

b) Expected sales in 2022

Sales for 2021 2,500,000

Volume impact 36% up
Price impact 10% down
Sales for 2022 3,060,000

Sales required to achieve profit 3,865,410

Expected sales in 2022 3,060,000
Shortfall (805,410)

By dropping the selling price to 90% to achieve an increase in sales of

36% will not be sufficient to achieve the target profits