A company had sales of £18 last year and a coverage ratio of 40% and a profit of

Question

A company had sales of £18 last year and a coverage ratio of 40% and a profit of £3 Next year, major changes are predicted to lead to the expectation that: Fixed costs will increase by 46% Sales will increase by 25% The coverage is assumed to remain unchanged. Questions: 1. What is the estimated earnings for next year? Answer in £. (Also the answer is not £6.13) 2. What is the percentage change (not percentage points) of the profit margin in relation to last year? Answer in %. (Also, the answer is not 46%)

Explanation / Answer

So, here we need to do back calculations to get the initial figures.

We know sales is 18 and profit is 3, so that means there is a total expense of 15.

Here, coverage is actually EBITDA/Sales Coverage ratio.

So, now we see that EBITDA/Sales = 0.4 which will give us EBITDA = 18*0.4 = 7.2

So, our variable cost is 18- 7.2 = 10.8

And when we talk about fixed cost, we are having 7.2-3 = 4.2

Now, see the following proforma of calculations :-

i) Estimated earning of next year is (0.912) which is a loss.

ii) Percentage change in profit margin is (124.3%)

Particulars Current Year Expectations Next Year Sales 18 25% 22.5 Variable expenses 10.8 60% 17.28 EBITDA 7.2 40% 5.22 Fixed Expenses 4.2 46% 6.132 Earnings 3 -0.912 Profit Margin 16.7% -4.1% Percentage change in Profit Margin -124.3%

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