Lecture 9 notes

 In the last lecture a new topic was introduced: Financial Performance

Analysis [the technique used for financial analysis is ‘Accounting
Ratios’]. Please revise the power point presentation [notes] uploaded
separately on the portal called: Financial Performance Analysis. Most
of it was covered in the last lecture.
 Complete the rest of the slides, the examples as well as the exam type
question at the end of the notes/slides.
 Please attempt new questions: K plc [on CVP Analysis] and L plc [on
Financial Performance Analysis] during the holidays and keep them
ready.
 You are NOW very close to the exam date – 19/01/2022. So, accuracy
and time management are important – PRACTICE, PRACTICE &
PRACTICE to achieve these skills.
 In the remaining 3 lectures in January, 2022, all questions set out in this
note and the mock exam will be done before the examination on the
19/01/2022.
 During the holidays please review all topics done in all lectures. Do
email me if you have any questions that may require any clarification.
 Please see below answer for J Ltd. Revise it before doing K plc.
 The Mock Exam will be uploaded to the portal by 24/12/2021 at the
latest.

CVP Analysis Question – J Ltd

J Ltd manufactures and sells kitchen electric products for domestic use. A new product, an
electric kettle, is planned for in 2022. Details of this planned launch is as follows.

Selling price per kettle is £25 and expect to sell 35,000 kettles.
Variable costs of production and sales are £15 per kettle.
Total fixed costs specific to the new kettle product line is expected to be £220,000 and the
maximum production capacity is 50,000 kettles.

Required:

a) Breakeven sales volume and sales revenue.

Contribution per kettle = £ [25 – 15] = £10 per kettle
C/S ratio = £10 / £25 = 0.4

BEP in sales volume: [kettles] = Total fixed costs / Contribution per kettle
= £220,000 / £10 = 22,000 kettles.
BEP in sales revenues; [£] = Total fixed costs / C/S ratio
= £220,000 / 0.4 = £550,000

b) Budgeted profit.
Budgeted profit = Total contribution – Total fixed costs
= £10 x 35,000 - £220,000 = £350,000 - £220,000
= £130,000.
c) Margin of safety.

Margin of safety = Sales – BEP = 35,000 – 22,000 = 13,000 kettles

Alternative answer: Margin of safety [£] = 35,000 kettles x £25 - £550,000

= £875,000 - £550,000 = £325,000

d) The sales volume and sales revenue required to make a profit of £100,000.

Profit required = £100,000

Contribution required = Total fixed costs + Profit = £220,000 + £100,000 = £320,000

Sales volume required = Contribution required / Contribution per kettle

= £320,000 / £10 = 32,000 kettles.

Sales revenue required = Contribution required / C/S ratio = £320,000 / 0.4 = £800,000

e) If the selling price reduces by £2 per kettle, calculate the budgeted profit for the
35,000 kettles and the breakeven point. Comment briefly on the results

Revised selling price per kettle = £[25 – 2] = £23

Revised contribution per unit = £[23 - £15] = £8

OR
Revised contribution per kettle = £[10 – 2] = £8

Budgeted profit = 35,000 x £8 - £220,000 = £280,000 - £220,000 = £60,000

BEP [Kettles] = £220,000 / £8 = 27,500 kettles

Comment: A reduction in the selling price, reduces the contribution per kettle, reduces total
contribution and consequently reduces profit. It increases the breakeven point and which
reduces the margin of safety.

f) How do businesses lower their BEP?

BEP [units] = Total fixed costs / Unit contribution

 Increase the selling price.
 Reduce the variable costs e.g. reduce the packaging; use cheaper resources like
materials.
 Reduce total fixed costs e.g. reduce advertising and promotion/marketing costs
 Or do any combination of the above.
g) Discuss the limitations of the above analysis. [10 marks]

 Assumption 1: All costs can be analysed into variable and fixed costs.
Limitation: Not all costs can be analysed in this way. There are other types of cost
behaviour. These are excluded.
 Assumption 2: Selling price per unit, variable cost per unit and total fixed costs are
expected to remain constant within the relevant range/maximum capacity.
Limitation: These usually could change within the relevant range.
 Assumption 3: All production is sold.
Limitation: There could be changes in inventory level.
 Assumption 4: All other factors [production method, advertising & promotion,
distribution method] affecting the analysis are assumed to be constant within the
relevant range.
Limitation: These variables could change within the relevant range and hence affect
the analysis of the costs and selling prices.
 Assumption 5: Production-sales mix is expected to remain constant.
Limitation: This means the contribution per mix and its C/S ratio is constant.

CVP Analysis Question: K plc

K plc is to launch a new computer game. You are provided the following financial
information for this product.

Sales volume and selling price: 270,000 games at £120 per game.
Variable costs per game: £70.
Fixed costs are expected to be £10,000,000.

Maximum capacity to produce and sell is 300,000 games.

Proposals for L plc to consider are:

Proposal 1: Increase the selling price by 10%; improve the product quality by
spending an extra £3 per game. The expected sales would then be 230,000 games.
Proposal 2: Decrease the selling price to £115 per game and sell 275,000 games.
Proposal 3: Increase the selling price to £130 per game, spend an additional
£500,000 on marketing, and sell 255,000 games.

Required [for 30 marks]:

a) Calculate the breakeven point and profit for the original budget. [6 marks]
b) Calculate the profit, breakeven point and margin of safety for all 3
proposals. [9 marks]
c) Explain which of the above [original budget and the 3 proposals] you
would recommend. [5 marks]
d) Discuss the limitations of the above analysis. [10 marks]
DID YOU ATTEMPT ALL THE QUESTIONS (a) to (d) without looking
at the answers to the previous CVP Analysis question [J Ltd]? Also, did
you time yourself?

Financial Performance Analysis Question: L plc

The latest financials for L plc are summarized below:

Income statement (extracts) for the year ended 31/12/2019 (in £000s)

Sales revenue 1,650

Cost of sales 1,070
Expenses 110

Statement of financial position as at 31/12/2019 (in £000s)

ASSETS
Non-current assets 3050
Current assets
Inventory 250
Trade receivables 300 550
Total Assets 3600

EQUITY & LIABILITIES

Ordinary share capital 500
Retained profit 2100
Total Equity 2600
Non-current liabilities: 8% Bank Loan 500
Current liabilities
Trade payables 80
Bank overdraft 420 500
Total Equity & Liabilities 3600

Key financial indicators are available for M plc [a company within the same industry
as L plc] for 2019:

Net profit ratio 20%

Gross profit ratio 30%
Current ratio 1.8:1
Quick ratio / Acid test 1.1:1
Receivables collection ratio (days) 30
Payables (days) 40
Inventory holding (days) 60
Required:

a) Calculate equivalent ratios (as above) for L plc.

b) Critically discuss the performance of L plc as compared to that of M plc

using the ratios calculated.

PLEASE GO BACK TO THE NOTES ON THIS TOPIC – ‘FINANCIAL

PERFORMANCE ANALYSIS.’ This power point presentation [notes]
uploaded separately on the portal will help to deal with the above question.

Note to ALL students:

 Please ignore the distasteful/adverse exchanges/comments made by 2 students in
the last lecture. Do NOT let this disrupt your serious attempt to study this module in
these challenging circumstances. I have done my best for anyone willing to seriously
study this module and I appreciate ALL those who seriously engaged as well and did
their best.

 So, I thank all you for helping me to guide you during these lectures in these
challenging times. It was my absolute pleasure to guide all you. Appreciate your
effort in learning and helping me in the teaching.

 All of you will benefit of the 2 weeks break to revise and catch up with all 4 topics
before the exams [previous groups did not have this 2-week break before their
exam]. Wish all of you the season’s greetings and a wonderful Happy New Year.

END OF LECTURE 9 NOTES

Please take note of TWO additional lectures as follows in the new

year. All can attend any of the lectures including their own. Get
the zoom links from Kyle or Teaching Assistants:

On Monday, 10/01/2022 for Groups C [6pm]

On Tuesday, 11/01/2022 for Groups A [10.30am], B [1.30pm] and C [6pm] .

On Wednesday, 12/01/2022 for Groups A [10.30am], B [1.30pm]