Heaven Ltd produces one type of sofa beds and the details per month are as follo

ID: 2488087 • Letter: H

Question

Heaven Ltd produces one type of sofa beds and the details per month are as follows: Selling Price (per unit): £700 Variable cost per unit (including labour, material and other costs £400 Fixed cost per month £120,000 Budgeted production/sales per month (in units) 800 a. Calculate profit or loss expected if budget of selling 800 units is to be achieved. (2 marks) b. Calculate how many beds need to be sold per month in order to achieve break even point (BEP) and briefly explain what it means for Heaven Ltd. (3 marks) c. If shop aims to make a profit of £150,000 per month, how many sofa beds should be sold per month. (2 marks) d. Calculate margin of safety in units as well as percentage terms and briefly explain what it means for Heaven Ltd. (3 marks) (Total: 10 marks)

Explanation / Answer

Solution:

a) Calculation of expected profit or loss if budget of selling 800 units is to be achieved

Income Statement

Budgeted Production/Sales Per month

800 Units

Sales Revenue (800*700)

£560,000

Variable Cost (800*400)

£320,000

Contribution Margin (Sales - Variable Cost)

£240,000

Fixed Costs

£120,000

Profit (Contribution - Fixed Costs)

£120,000

Break Even Point (BEP) in units = Total Fixed Costs / Contribution Margin Per Unit

Contribution Margin Per Unit = Selling Price – Variable Cost = 700 – 400 = 300 Per Unit

Break Even Point (BEP) in units = 120,000 / 300 = 400 beds

BEP means the level of sales at which fixed cost of the company is recovered. At BEP Point no profit no loss to the firm. For every business it is very important to achieve BEP point. Because it is primary requirement of a business concern to achieve its BEP point. After getting BEP point, all the contribution earn by the firm will become their profit.

In the give question, Heaven Ltd is required to sale 400 beds to recover its operating fixed cost.

Desired Sales in Beds (Units) to make a profit of £150,000 per month = ( Fixed Costs + Desired Profit ) / Contribution Margin per unit

= (120,000 + 150,000) / 300

= 900 beds

Shop should sell 900 beds per month in order to make profit of £150,000 per month

Margin of Safety in Units = Sales Units – BEP Sales Units = 800 Units – 400 Units = 400 Units

Margin of Safety in percentage term = Margin of Safety in value / Sales Revenue x 100

Margin of Safety in value = Sales – BEP Sales = £560,000 – (400*700)

= 560,000 – 280,000

= 280,000

Margin of Safety in percentage term = 280,000 / 560,000 x 100 = 50%

Margin of safety is the sales value over and above the BEP Points. Higher the Margin of Safety lower the BEP Point and better is the position