STRATEGIC COST MANAGEMENT

QUIZ 1

MODULE 1 FINANCIAL ACCOUNTING VS

INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING
COST MANAGEMENT AND ● Accounting as the language of business
has the primary goal of providing useful
MANAGEMENT ACCOUNTING information for decision making in selecting
among various alternatives.
STRATEGIC COST MANAGEMENT ● Main difference: Intended user of the
● Pertains to the use of cost data to develop information
and identify superior strategies that will
produce a sustainable competitive
Financial Managerial
advantage. Accounting Accounting
● Generic Competitive Advantage
➔ Superior Efficiency User perspective External users, Internal users,
➔ Superior Quality such as investors such as
and creditors management and
➔ Superior Innovation employees
➔ Superior Customer
Responsiveness Types of reports/ Financial Monetary and non-
information statements; monetary reports
● Competitive Advantage is creating better primarily such as budgets,
customer value. monetary performance
● Customer Realization (Satisfaction) - (financial) in evaluation and
Customer Sacrifice (Amount that they paid) nature cost reports
= Customer Value
Guiding Generally Management
Principles Accepted wants and needs
STRATEGIES FOR INCREASING Accounting
CUSTOMER VALUE TO ACHIEVE Principles
COMPETITIVE ADVANTAGE (GAAP)
● Cost Leadership: Less Customer
Sacrifice Purpose or Financial Decision-making
End Result reporting and
➔ The company seeks to provide the
compliance
same or better service at a lower
cost than offered by competitors. Necessity Mandatory Discretionary or
➔ This is one way to increase (especially for optional
customer value by minimizing public entities)
customer sacrifice or the cost of
producing the product or services. Time Mainly historical Future-oriented
● Differentiation: Increased Customer Orientation (past) data using current and
past data
Realization
➔ The company strives to increase Nature of Objective, Subjective,
what the customer receives. Information reliable, and relevant, and
➔ The focus is on creating better historical future oriented
quality products and services.
● Focusing: Emphasis on a market or Frequency of Prepared Prepared as
Reporting periodically needed, perhaps
customer segment.
(monthly, day-to-day or
➔ The company focuses on a certain quarterly, even in real time
demographic (Ex. Teenagers) annually)
➔ Helps to minimize the cost and
maximize customer satisfaction; Level of Detail Focus mainly on Extensive and
thus, increase customer value. business as a detailed
● Strategic Positioning: The process of whole
selecting an optimal mix of the three
general approaches (Cost Leadership, COST ACCOUNTING
Differentiation, and Focusing) ● Subset of the Financial and Managerial
Accounting.

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 ● Utilized for internal reporting for use in ● Management by Exceptions (MBE) -
management planning and control, and Technique of highlighting those which
external reporting. varies significantly from plans and
standards in line with the management
FUNCTIONS OF MANAGEMENT principle that executives' time should be
● Planning/Organizing - Sets short term or spent on items that are non-routine and are
long term objectives/goals identified as priority.
➔ Also sets the need resources and ➔ Significant variances only
tactics to achieve the set ➔ Focuses on non-routine items
objectives/goals. ➔ Compares the actual and planned
➔ Selects the best alternative that is results of all activities on a given
best suited to attain the set period.
objectives through decision ➔ Investigates further when the
making. difference or the variance is
● Directing/Leading - Actual significant enough.
implementation of the plan ➔ Usually, insignificant variances are
➔ Taking action to make the plan neglected by the management.
materialize.
➔ BENEFITS
➔ Motivate others to achieve the goal. 1. Efficient time - - the
● Controlling - Comparing the actual management only focuses
performance with the set plans or on the significant variances
standards involving the operations
➔ Actual vs. Planned Performance 2. Efficient resources
➔ Consistently monitoring results to ➔ WEAKNESS
determine if the plan is achieved 1. This concept is based on
➔ Decide corrective action to take the existence of a budget
should there be any deviation, against which actual results
variance, or difference from the are compared. Budget not
actual plan formulated, many irrelevant
➔ Adjust future plans variances.
● Decision Making - Choosing among
competing alternatives TREASURER VS CONTROLLER
➔ Present in all other functions of the
Raising capital Supervision of
management
accounting department
MANAGEMENT BY OBJECTIVES VS Safeguarding of assets Preparing information
MANAGEMENT BY EXCEPTIONS and reports for
● Management by Objectives (MBO) - A managerial and
procedure in which a subordinate and a financial accounting
supervisor agree on goals and methods of
achieving them and developing a plan in Management of
accordance with that agreement. finances
➔ Afterwards, the subordinate is (Investments, credit
evaluated with reference to the policies, insurance
agreed plan at the end of the coverage)
period.
Finance Accounting and
➔ Goals, Plans, Methods, Evaluation Reporting
➔ BENEFITS
1. Employee motivation and Under the CFO Under the CFO
commitment
2. Better communication
➔ WEAKNESS SUMMARY OF FUNCTIONS
1. Emphasis on setting goals, Controller Treasurer
not on the systematic plan
to do so. Planning and Control Provision of Capital

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 ● Competence - Maintain an appropriate
Reporting and Investor Relations
level of expertise and continually
Interpreting
developing knowledge and skills
Evaluating and Short-term Financing ➔ Has to perform duties according to
Consulting law and ethical standards
➔ there is a need to report that we do
Tax administration Banking and Custody not have the necessary skills,
expertise, or knowledge regarding a
Government Reporting Credit and Collections certain task, position, or rule.
● Confidentiality - Keep information
Economic Appraisal Investments confidential except disclosure is authorized
or legally required
Insurance
➔ Refrain from using confidential
information for unethical or illegal
INTERNAL AUDITOR advantage
● Responsible for reviewing the accounting ● Integrity - Mitigate actual conflicts of
procedures, records, and reports in both interest
the controller’s and treasurer’s areas of ➔ Refrain from engaging in any
responsibility conduct that would prejudice
● Expresses an opinion to top management carrying out duties ethically
regarding the effectiveness of the ➔ Refrain from engaging or
organization’s accounting system supporting any activity that might
● May also make broad performance discredit the profession
evaluation in middle and lower ● Credibility/Objectivity - Communicate
management information fairly and objectively
● Make sures that the controls are in place, ➔ Must disclose all relevant
the process is effective and efficient. information that could reasonably
be expected to influence an
LINE FUNCTION VS STAFF FUNCTION intended user’s understanding of
● Line Function - Authority to give command the reports, analyses, or
or orders to subordinates. recommendations.
➔ It exercises direct downward ➔ EX. applying for a loan from a bank,
authority over line departments. the accountant of the company
➔ Directly involved in the provision of shall disclose all relevant
goods and services. information that would affect the
➔ EX. Sales Manager, VP-Operation, decision of the bank regardless
COO & CEO whether that information would put
● Staff Function - Authority to advise but not the company at a disadvantage.
to command others.
➔ Provides line and other staff MAJOR IMPROVEMENT
personnel with specialized TOOLS/PROGRAMS OR APPROACHES
technical advice for support USED BY MODERN MANAGERS
➔ Exercised laterally or upward ● The business environment has been
➔ Supervises activities that support characterized by increasing competition
the organization’s overall mission and relentless drive for continuous
➔ Indirectly involved with operational improvement. As business turned global
activities and product lines expanded, operations
➔ EX. HR Managers, IT Dept. Head, have become more complex and forward
Comptroller, Treasurer, VP- looking, companies saw a tremendous
Finance, CFO & General Counsel need for management-oriented data that
was separate from financial-oriented data.
PROFESSIONAL ETHICS ● Total Quality Management - Used by an
● Ethics - Standards of conduct for judging organization that is centered on quality
right from wrong, honest from dishonest, based on the participation of all members
fair from unfair. and aiming for long-term success through
customer satisfaction and benefits to all
CODE OF ETHICS members of the organization and to
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 society. In total quality management, from ➔ Setting the selling price is the first
the lowest level up to the highest level step. Afterwards, the markup. The
position are involved in gradually attaining difference between the two will be
improvement on the quality of their work. the target cost. This cost would not
● Just-in-time - A philosophy when to do be the same and may not be the
something. “When” as needed and same as the current cost of
“Something” as to production, purchasing producing the product. Then, the
or delivering activities. Not manufacturing management would find ways to
or creating a product in advance. produce the product based on that
● Flexible Manufacturing System - A single target cost.
factory manufactures numerous variations ➔ Under this theory, the dependent
of products through the use of computer variable is the cost not the selling
controlled robots. price.
● Theory of Constraints - Method of ● Value Engineering - pertains to the
analyzing the bottlenecks or constraints disciplined search for various feasible
that keep a system from achieving higher combinations of resources and methods
performance. that will increase product functionality and
➔ Under this theory, if you are to reduce costs.
successfully manage the ➔ We try to look for the various
constraints or the bottlenecks feasible combinations that will be
wherein the delays happen, there is more efficient or more effective in
a greater chance for us to create a terms of producing our product.
successful operation or company. ● Process Reengineering - More radical
● Life Cycle Costing - Accumulates the cost approach to improvement than TQM.
for activities that occur over the entire life Instead of tweaking the existing system in
cycle of a product from inception to a series of incremental improvements, a
abandonment by the manufacturer and the business process is diagrammed in detail,
consumer. questioned, and completely designed to
➔ Traditionally, in costing products eliminate unnecessary steps to reduce
and eventually setting prices for opportunities for errors and to reduce
them to be sold to customers, we costs.
consider only the manufacturing ➔ We analyze the existing process in
cost - how much have we incurred detail and then we try to redesign it
in manufacturing this product and immediately by eliminating the
then we set a markup for that which unnecessary steps to reduce
will be the selling price opportunities for error and to
➔ In life cycle costing, all costs minimize the cost.
incurred from cradle to grave will be
considered in selling prices. This MODULE 2
means even if it is not yet being
manufactured and is still in the
COST-VOLUME PROFIT ANALYSIS
research or development phase,
these costs will be considered that CVP ANALYSIS
isa departure from standard which ● A short - run model that focus on the
is only allowed in managerial relationships among:
accounting. ➔ Sales price
● Activity Based Costing - Using multiple ➔ Volume
cost drivers to predict and allocate cost to ➔ Costs
products and services.
➔ Profits
➔ Collects information such as ● It studies the impact of changes in sales
financial and operational data on and in cost on the profits of the company.
the basis of underlying nature and Hence, this can be helpful to managers in
extent of business activities their planning function.
● Target Costing - Method of determining
what the cost of the product should be
based on the product’s estimated selling
CONTRIBUTION MARGIN APPROACH
price less desired profit. ● CVP analysis uses the contribution margin
approach, the one that we used in variable
costing.
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 ● The Contribution Margin Income
CM per Unit (CMU) = SP/u - VC/u
statement is used only for internal decision
or
making because this is not PFRS-
CM per unit (CMU) = Total CM / no. of
compliant.
units
● This also segregates costs according to
ANS. 6 = 2,400/400
their behavior: variable and fixed.
● Instead of whether they are product cost or
period cost such as COGS, selling, or CM ratio (CMR) = Total CM / Sales Rev.
general and administrative expenses. or
● This approach is helpful in aiding sensitivity CM ratio (CMR) = CMU / SP/u
or what-if analysis. ANS. 60% = 2,400 / 4,000

Sales Pxx 2. How much will operating income be if only

300 units will be sold instead of 400?
Less: Variable (xx)
costs
Sales (350 units) P3,500
Contribution Pxx
margin Less: Variable (1,400)
costs (350*4)
Less: Fixed costs (xx)
Contribution P2,100
Operating profit Pxx margin

Less: Fixed costs (1,800)

SAMPLE PROBLEM
Operating profit P300
Sales (400 units) P4,000

Less: Variable (1,600) SP/u = P4,000/400 units = P10

costs VC/u = P1,600/400 units = P4

Contribution P2,400
margin Profit = (CMU x Units) - Fixed Costs
P300 =(P6 x 350) - P1,800
Less: Fixed costs (1,800)

Operating profit P600 3. How much will operating income increase

if 500 units will be sold instead of 400?
1. Determine the total contribution margin,
contribution margin per unit, and the
Sales (500 units) P5,000
contribution margin ratio.
a. Compute first the selling price per Less: Variable (2,000)
unit and the variable cost per unit. costs (500*4)
SP/u = P4,000/400 units = P10
VC/u = P1,600/400 units = P4 Contribution P3,000
margin
b. Compute the total contribution Less: Fixed costs (1,800)
margin.
TOTAL CM = Sales Rev. - VC Operating profit P1,200
P2,400 = 4,000 - 1,600
SP/u = P4,000/400 units = P10
c. There are 2 different ways to solve VC/u = P1,600/400 units = P4
the contribution margin per unit. CMU = P6
First, by using the unit selling price
and the variable cost per unit. Thus,
this is the difference between 10 Changes in profit = Inc.(Dec) in units x
pesos and 4 pesos
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 CMU
P600 = (100 units x P6)

4. How much will operating income be if

variable cost per unit is P5?

Sales (400 units) P4,000 CVP UNDERLYING ASSUMPTIONS

● Revenues and costs behave in a linear
Less: Variable (2,000)
manner.
costs (400*5)
➔ This is possible because of the unit
Contribution P2,000 prices and cost being constant.
margin ● Costs are either variable or fixed.
➔ Other costs such as step cost will
Less: Fixed costs (1,800) not be considered.
● Only volume affects the cost and
Operating profit P200 revenues.
➔ Other factors such as the demand
purchase and sales discount will be
SP/u = P4,000/400 units = P10 ignored in the analysis
VC/u = P1,600/400 units = P5 ● Production volume = sales volume.
➔ In this case, we are going to
assume that finished goods and
Profit = (CMU x Units) - Fixed costs
work in process inventories do not
P200 = (P5 x 400) - 1,800
change significantly.
● Product mix is constant.
CVP GRAPH ➔ Normally, companies sell multiple
● Based on the foregoing information, products and the combination of
construct a CVP graph for the revenues this in terms of sales does not
and costs data: change significantly.
● SP = P10 VC = P4 FC = P1,800 ● Time value is ignored.
➔ Since volume profit is a short-run
UNIT LEVEL 100 200 300 400 500 model, the time value factors are
ignored because they are
SALES P1,000 P2,000 P3,000 P4,000 P5,000
insignificant in the short run.
LESS: VC (400) (800) (1,200) (1,600) (2,000)

CM P600 P1200 P1,800 P2,400 P3,000 BREAKEVEN POINT

● It is the level of sales and production at
LESS: FC (1,800) (1,800) (1,800) (1,800) (1,800) which the company earns no profit nor
OPERATING (P1200) (P600) -P0- P600 P1,200 incurs any loss.
PROFIT(LOSS) ➔ TOTAL REVENUE = TOTAL
2,200 2,600 3,000 3,4003 3,800 COSTS
➔ Can be expressed in terms of units
or in terms of sales amount
➔ BEP in Units = TFC / CMU
➔ BEP in Revenue = TFC / CMR

SAMPLE PROBLEM
Ray Co. manufactures cell phones and sells them
to wireless service providers for $60, Ray Co. 's
variable cost is $36 per phone. The total amount of
fixed costs amounted to $150,000. Determine the
BEP in Units and Sales Revenue.
1. BEP in Units = TFC / CMU
CMU = 60 - 36 = 24
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 6,250 = 150,000 / 24
Required sales (unit) x SP/u
We need to sell 6,250 units for the
P25,600 = 6,400 units x 4
company to breakeven. To determine the
BEP in revenue, multiply the BEP in units
by the selling price. Required sales (revenue) = (FC + Target
6,250 units x 60 = $375,000 profit) / CMR
CMR = CMU / SP/u
2. BEP in Revenue = TFC / CMR 37.5% = P1.50 / P4.00
CMR = 24/60 = 40%
$375,000 = 150,000 / 40% P25,600 = (P4,600 + P 5,000) / 37.5%
To determine the BEP in units, divide the
BEP in revenue by the selling price. To determine the required sales (units):
$375,000 / 60 = 6,250 units Required sales (revenue) / SP/u
6,400 units = P25,600 / 4
CHECKING
● SP = P60; VC = P36; FC = P150,000
CHECKING
Sales (6,250 units) P375,000 ● SP = P4; VC = P2.5; FC = P4,600

Less: Variable (225,000) Sales (6,400 units) P25,600

costs (6,250*36)
Less: Variable (16,000)
Contribution P150,000 costs (6,400*2.5)
margin
Contribution P9,600
Less: Fixed costs (150,000) margin
Operating profit -0- Less: Fixed costs (4,600)

Operating profit P5,000

PROFIT REQUIREMENT
● In most cases, companies do not just want ● Thus, the required level of sales in terms of
to break even. units should be at least 6,400 and the
● To earn profit is a must for most of these required level of sales in terms of revenue
businesses. Otherwise, they will be forced should be at least 25,600 to achieve the
to close. minimum profit requirement of P5,000.
● Using CVP analysis, managers will be able
to determine the needed sales to achieve a 2. Profit margin of 35% of sales
certain profit requirement.
● This profit requirement may be expressed Required sales (unit) = FC / CMU -
in amounts or in a percentage form such as Profit margin per unit
target profit margin.
➔ Target profit amount Profit margin per unit = profit margin x
➔ Target profit margin SP/u
1.4 = .35 x 4
ILLUSTRATION
Assume the ff: The selling price of a product is 46,000 units = P4,600 / (P1.50 - P1.40)
P4.00, variable costs are P2.50, and fixed costs
are P4,600. Compute for the required sales level To determine the required sales
to achieve the ff. independent targets: (revenue):
1. Minimum profit of P5,000 Required sales (unit) x SP/u
P184,000 = 46,000 units x 4
Required sales (unit) = (FC + Target
profit) / CMU Required sales (revenue) = FC / CMR -
6,400 units = (P4,600 + P 5,000) / P1.50 Target Profit Margin
To determine the required sales P184,000 = P4,600 / (37.5% - 35%)
(revenue):
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 To determine the required sales
To determine the required sales (unit): (revenue):
Required sales (revenue) / SP/u Required sales (unit) x SP/u
46,000 units = 184,000 units / 4 P32,000 = 8,000 units x 4

CHECKING Required sales (revenue) = (FC + Target

● SP = P4.00; VC = P2.50; FC = P4,600 profit) / CMR
Sales (46,000 P184,000 CMR = CMU / SP/u
units) 37.5% = P1.50 / P4.00

Less: Variable (115,000) P32,000 = (P4,600 + P7,400) / 37.5%

costs (46,000*2.5)
To determine the required sales (units):
Contribution P69,000 Required sales (revenue) / SP/u
margin 8,000 units = P32,000 / 4

Less: Fixed costs (4,600)

CHECKING
Operating profit P64,400 ● SP = P4.00; VC = P2.50; FC = P4,600

● Operating profit / sales = 64,400 /184,000 Sales (8,000 units) P32,000

= 35%
Less: Variable (20,000)
AFTER-TAX PROFIT REQUIREMENT costs (8,000*2.5)
● At break even point, tax rate is irrelevant
Contribution P12,000
because at this point no profit is earned by
margin
the company; thus, the company does not
owe any taxes to the government. Less: Fixed costs (4,600)
● However, since companies normally have
profits, tax rate may be relevant especially Operating profit P7,400
if the target profit is set at after tax amounts
or margins as such additional need is Less: Income tax (2,960)
needed. (7,400 x 40%)
● Convert after tax requirements to pre-tax
values. Net profit 4,440
● Thus, the company needs to sell at least
ILLUSTRATION 8,000 units or earn at least 32,000 revenue
Assume the ff: The selling price of a product is in order for the company to achieve the
P4.00, variable costs are P2.50, and fixed costs minimum after tax profit of P4,440.
are P4,600. The relevant tax rate is 40%. Compute
for the required sales level to achieve the ff. 4. After-tax profit margin of 19.50% of sales
independent targets:

3. Minimum after-tax profit margin of P4,440 = 19.50% / (1-T)

= 19.50% / (1 - 40%)
= 19.50% / 60%
= 4,440 / (1-T) After-tax profit requirement = 32.50%
= 4,400 / (1 - 40%) (profit margin)
= 4,400 / 60%
Minimum pre-tax profit requirement =
P7,400 (target profit) Required sales (unit) = FC / CMU - Profit
margin per unit
Profit margin per unit = profit margin x
Required sales (unit) = (FC + Target SP/u
profit) / CMU 1.30 = .325 x 4
8,000 units = (P4,600 + P 7,400) / P1.50 23,000 units = P4,600 / (P1.50 - P1.30)

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 To determine the required sales ILLUSTRATION
(revenue): Information related to ABC Company’s products
Required sales (unit) x SP/u are as follows:
P92,000 = 23,000 units x 4
Product A Product B

Required sales (revenue) = FC / CMR - Projected unit 30,000 45,000

Profit margin sales
CMR = CMU / SP/u Selling prices P4.00 P3.00
37.5% = P1.50 / P4.00 per unit

P92,000 = (P4,600 + P7,400) / 37.5% - Variable costs 2.50 1.75

per unit
32.5%
Total Fixed Cost P67,500
To determine the required sales (units):
Required sales (revenue) / SP/u
23,000 units = P92,000 / 4 Determine how many of each product needs to be
sold to breakeven.
CHECKING
● SP = P4; VC = P2.5; FC = P4,600 Product A Product B
Sales (23,000 P92,000 Sales Quantity 40% 60%
units) Mix (30,000/75000) (45,000/75000)

Less: Variable (57,500) CMU 1.50 1.25

costs (23,000*2.5) (4.00 - 2.50) (3.00 - 1.75)

Weighted 1.35
Contribution P34,500 Average CMU (.40 x 1.50) + (.60 x 1.25)
margin

Less: Fixed costs (4,600) SALES QUANTITY MIX

Operating profit P29,900
BEP in units= TFC / Weighted average
Less: Income tax (11,960) CMU
(P29,900 x 40%) 50,000 units = 67,500 / 1.35

Net profit 17,940 Number of units particular to each

product that are needed to be sold to
breakeven:
● NET PROFIT / SALES REVENUE = After
tax profit margin
Product A = BEP in units x Sales
P17,940 / P92,000 = 19.5%
Quantity Mix A
Product A = 50,000 x.40
MULTIPLE PRODUCTS Product A = 20, 000 units
● Firms usually introduce a diverse product
line and the individual products will have Product B = BEP in units x Sales
different: Quantity Mix B
➔ different selling prices Product B = 50,000 x .60
➔ different contribution margins Product B = 30,000 units
➔ different contribution margin ratio
● Firm's total fixed cost may be the same no
matter the mix of products sold. This can Question: What is the BEP in Revenue?
cloud the ability to perform simple CVP
analysis. BEP in Revenue = Allocated units for
● The mix given may be a percentage of the each product x Selling Price per unit
volume known as sales quantity mix or the
amount known as sales revenue mix.
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 Product A = 20, 000 units x 4.00
Product A = P80,000 BEP in Revenue = TFC / Weighted
average CMR
Product B = 30,000 x 3.00 P220,000 = P121,000 / 55%
Product B = P90,000
Particular revenue to each product that
BEP in Revenue = P80,000 + P90,000 are needed to be sold to breakeven:
= P170,000
Product A = BEP in Revenue x Sales
Revenue Mix A
CHECKING Product A = P220,000 x .25
Product Product Total Product A = P55,000
A B
Product B = BEP in Revenue x Sales
Sales P80,000 P90,000 P170,000 Revenue Mix B
Less. (P50,000) (P52,500) (P102,500)
Product B = P220,000 x .75
Variable Product B = P165,000
costs

Contributio P30,000 P37,500 P67,500 Question: What is the BEP in Units?

n Margin
BEP in Units = Allocated revenue for
Less. Fixed (P67,500) each product / Selling Price per unit
Cost

Operating 0 Product A = P55,000 / 4.00

Profit Product A = 13,750 units

Product B = P165,000 / 5.00

Product B = 33,000 units
SALES REVENUE MIX
Information related to ABC Company’s products BEP in Revenue = 13,750 + 33,000
are as follows: = 46,750 units

Product A Product B
CHECKING
Projected Sales P120,000 P360,000
Revenue Product Product Total
A B
Selling prices P4.00 P5.00
per unit Sales P55,000 P165,000 P220,000

Variable costs 2.40 2.00 Less. (P33,000) (P66,000) (P99,000)

per unit Variable
costs
Total Fixed Cost P120,000
Contributio P22,000 P99,000 P121,000
n Margin

Determine how many of each product needs to be Less. Fixed (P121,000)

Cost
sold to breakeven.
Product A Product B Operating 0
Profit
Sales Revenue 25% 75%
Mix (120,000 / (360,000 /
480,000) 480,000)
SUMMARY
CMR 40% 60% ● The formula to be used would depend on
(1.60 / 4) (3.00 / 5)
the product mix given:
Weighted 55% ➔ sales QUANTITY mix
Average CMR (.25 x .40) + (.75 x .60) ◆ FORMULA: BEP in units =
TFC / Weighted average
CMU
SALES REVENUE MIX
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 ➔ SALES REVENUE mix MARGIN OF SAFETY RATIO
◆ FORMULA: BEP in
Revenue = TFC / Weighted
BEP in Revenue = TFC / Weighted
average CMR
average CMR
● To convert the answers:
➔ Units to Revenue P300,000 = P105,000 / 35%
◆ Multiply Selling Price
➔ Revenue to Units MoSR = Actual/Budgeted Sales -
◆ Divide Selling Price Break Even Sales / Actual/Budgeted
Sales
MARGIN OF SAFETY
● Margin of safety is the difference between 25% = P400,000 - P300,000 / P400,000
actual or budgeted sales and the break-
even point or the break-even sales.
Interpretation: The company sales can decline by
● This pertains to the amount of budgeted or
P100,000 or 25% before the company operates at
actual sales that can fall before it will result
a loss.
in a loss. This is known as BUFFER ZONE.
● The margin of safety can also be
expressed in ratio. This is known as the INDIFFERENCE POINT
MARGIN OF SAFETY RATIO. ● Companies usually have different cost
● The margin of safety ratio is calculated as structures. Cost structure is how a
actual or budgeted sales minus break even company uses a mix of variable costs and
sales, divided by the actual or budgeted fixed costs. It can either be:
sales. ➔ high variable costs - low fixed costs
● This is helpful in risk management. ➔ low variable costs - high fixed costs
● The indifference point is the level wherein
ILLUSTRATION the two cost structures are equal.
Given the following income statement, answer the ➔ cost structure A = cost structure B
following questions:

Sales Revenue P400,000

Variable cost 260,000

Contribution Margin P140,000

Fixed Costs 105,000 Can be solve by using:

● PROFIT FORMULA: Sales - Variable
Operating Income P35,000 Costs - Fixed Costs

Questions: Let x be the number of units

a. What is the MoS?
b. What is the MoSR? (50 - 21 - 7.50)x - 450,000 = (50 - 20 -
2.50)x - 550,000
MARGIN OF SAFETY 22.50x - 450,000 = 27.50x - 550,000
5x = 100,000
BEP in Revenue = TFC / Weighted x = 20,000
average CMR

P300,000 = P105,000 / 35% ● TOTAL COST FORMULA: Variable +

Fixed Costs
MoS = Actual/Budgeted Sales - Break
Even Sales Let x be the number of units

P100,000 = P400,000 - P300,000 22.50x + 450,000 = 27.50x + 550,000

5x = 100,000
x = 20,000

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 2.
● After arriving at the indifference point, the
Changes in profit = DOL x Change in
cost structure that should be selected
sales
would depend on the projection of the
Increase by 50% or 240,000 = 2.5x x
management. If the management expects
20%
to sell above the indifference point, the cost
structure with higher CM per unit should be 3.
selected as a result the company Changes in profit = DOL x Change in
maximizes the earning potential. sales
● On the other hand, if the management Decrease by 25% or 120,000 = 2.5x x
expects to sell below the indifference point, (10%)
the cost structure with lower fixed cost
should be selected to minimize the possible
losses. CHECKING
● SP = P100; VC = P40; FC = P720,000
DEGREE OF OPERATING LEVERAGE
● Comes from the word lever - one of the Sales Based on Sales
increased by projected decreased by
simple machines that amplifies the 20% sales of 10% (18,000
outcome of the effort exerted. (240,000 20,000 units units)
● In finance, leverage is that companies use units)

to increase assets, cashflows, and returns. Sales 2,400,000 2,000,000 1,800,000

It can also magnify losses.
● Two types of leverage: Less:
Variable
(960,000) (800,000) (720,000)

➔ Financial costs

◆ Financial leverage is a Contribution 1,440,000 1,200,00 1,080,000

metric that shows how much margin
a company uses debt to Less: Fixed (720,000) (720,000) (720,000)
finance its operation. costs
➔ Operating Operating 720,000 480,000 360,000
◆ Operational Leverage is profit
used to measure the extent
to which a company uses
fixed cost as a huge SUMMARY
component of its cost ● Higher DOL - machine-intensive,
structure. automated
● Lower DOL - labor-intensive, manual
● Which is better? Dependent on the
DEGREE OF OPERATING LEVERAGE expectation of the management.
● Measures how a percentage change in ● The company will maximize its returns by
sales will affect company profits. It having higher DOL
indicates how sensitive the company is to ● The company will minimize its losses by
sales volume increases and decreases. having lower DOL
● Operating leverage factor
“The higher the risk, the higher the returns” and so
ILLUSTRATION are the losses.

1.
DOL = Contribution Margin / Operating
profit
2.5x = 1,200,000 / 480,000

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