Question

1. What 5 questions does a break-even and contribution margin analysis attempt to answer?
2. How do changes in sales mix impact break-even and contribution margin analysis?
3. What are the limiting assumptions of break-even and contribution margin models?
4. How might a company establish profit targets?
5. How will Tesla’s recent production shut down impact its profit targets for 2018?

Answer 1

1. 5 questions does a break-even and contribution margin analysis attempt to answer are as below :-

1. What sales volume is required to break even?

2. What sales volume is necessary to earn a desired profit?

3. What profit can be expected on a given sales volume?

4. How would changes in selling price, variable costs, fixed costs, and output affect profits?

5. How would a change in the mix of products sold affect the break-even and target income volume and profit potential?

2.Changes in sales mix impact break-even and contribution margin analysis

Sales mix is the proportion in which two or more products are sold. For the calculation of break-even point for sales mix, following assumptions are made in addition to those already made for CVP analysis:

1. The proportion of sales mix must be predetermined.
2. The sales mix must not change within the relevant time period.

The calculation method for the break-even point of sales mix is based on the contribution approach method. Since we have multiple products in sales mix therefore it is most likely that we will be dealing with products with different contribution margin per unit and contribution margin ratios. This problem is overcome by calculating weighted average contribution margin per unit and contribution margin ratio. These are then used to calculate the break-even point for sales mix.

3. What are the limiting assumptions of break-even and contribution margin models

1. In the break-even analysis, we keep everything constant. The selling price is assumed to be constant and the cost function is linear. In practice, it will not be so.

2. In the break-even analysis since we keep the function constant, we project the future with the help of past functions. This is not correct.

3. The assumption that the cost-revenue-output relationship is linear is true only over a small range of output. It is not an effective tool for long-range use.

4. Profits are a function of not only output, but also of other factors like technological change, improvement in the art of management, etc., which have been overlooked in this analysis.

5. When break-even analysis is based on accounting data, as it usually happens, it may suffer from various limitations of such data as neglect of imputed costs, arbitrary depreciation estimates and inappropriate allocation of overheads. It can be sound and useful only if the firm in question maintains a good accounting system.

6. Selling costs are specially difficult to handle break-even analysis. This is because changes in selling costs are a cause and not a result of changes in output and sales.

7. The simple form of a break-even chart makes no provisions for taxes, particularly corporate income tax.

8. It usually assumes that the price of the output is given . In other words, it assumes a horizontal demand curve that is realistic under the conditions of perfect competition.

9. Matching cost with output imposes another limitation on break-even analysis. Cost in a particular period need not be the result of the output in that period.

10. Because of so many restrictive assumptions underlying the technique, computation of a break­even point is considered an approximation rather than a reality.

4. How might a company establish profit targets

Cost Control and Monitoring?

Helps devise a pricing strategy

Margin of Safety

Cost Calculation

Budgeting and Setting Targets

5. How will Tesla’s recent production shut down impact its profit targets for 2018

The latest shutdown comes just weeks after Musk tried to reassure jittery investors on Twitter that “Tesla will be profitable & cash flow+ in Q3 & Q4? with no need to raise more money in 2018. Moody’s Investors Service downgraded Tesla’s credit rating on March 27, citing the Model 3 shortfall, and the value of Tesla’s securities plunged as bond investors fled. But on April 12, Musk denied predictions it would face a $2.5 billion or greater cash shortfall this year, and the company’s stock rose 3% on the news.?The problems have arisen since Musk’s vision of a highly automated assembly line has crashed into the hard reality of moving from building luxury cars to mass-produced vehicles. The decision to use a complex, automated assembly process for the Model 3 defied the advice of Tesla executives, as well as many auto industry veterans who predicted catastrophe, because robots struggle with the fine adjustments in final assembly and malfunctions can stall the entire line for days or weeks. Musk has learned this lesson the hard way.?