Advantages And Disadvantages Of A Break-even Analysis
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Section A
Answer ALL questions. This section carries 60 marks.
Question A1
Dust ‘n’ Go (DG) specialises in cleaning homes and commercial premises such as offices. Homes are cleaned during the day whilst the homeowners are at work and offices in the evening after office workers have left for the day. The business was opened in 2010 by husband and wife Peter and Susan Jones. Originally the business was a partnership but, in 2017, they changed the legal structure to a private limited company. Susan is responsible for managing the home cleaning section of the business and Peter manages the office cleaning section.
DG has 30 employees who between them clean on average 200 homes and 100 offices per week. Twenty employees work in the home cleaning section and the remaining employees in the office cleaning section. All employees are paid a fixed rate per home or office cleaned; £20 and £30, respectively. Home clients pay £25 and office clients pay £40 per clean. In addition to the wage paid to each cleaner per house or office cleaned, there are other variable costs of £1 per clean. Annual fixed costs are £30,000. DG operates a 50-week year.
In recent months employees in the home cleaning section of the business have expressed their unhappiness at the amount of travel they do between cleaning assignments, time for which they are not paid. Some employees are cleaning on average 4 houses per day, but others only 3 per day because of the distance between assignments. Susan is concerned that labour turnover in the home cleaning section is increasing.
At a recent meeting, Peter and Susan discussed the lack of sales growth during the past 12 months and the decrease in profits of 8% compared to the previous year. They both agreed that increasing revenue was needed to improve profitability, but they had different ideas as to how this might be achieved. Peter proposed a 10% decrease in prices. Susan thought that they should increase promotional spending to attract more home and office clients. Further data is provided in Table 1 below in support of each proposal.
Table 1: Data provided by Peter and Susan in Support of their Proposal to increase Revenue
| Peter’s Proposal | ||
| Price reduction | Home clients per week
after price reduction (Forecast) |
Office clients per week
after price reduction (Forecast) |
| 10% | 240 | 108 |
| Susan’s Proposal | |||
| Current promotional spending | Proposed promotional spending | % Increase in home clients per week (Forecast) | % increase in office clients
per week (Forecast) |
| £20000 | £25000 | 4 | 2 |
Peter and Susan were in agreement that they needed to replace the company vehicle that was used to collect cleaning materials from wholesalers and deliver these to its employees. Susan estimates the cost of replacing the vehicle will be
£15,000 and that external sources will be needed to finance this investment.
- Explain two benefits to Peter and Susan of changing the legal structure of their business from a partnership to a private limited
[4]
- Calculate the annual total contribution DG earns from office [3]
- Discuss an advantage and a disadvantage of one action DG could take to reduce the labour turnover in the home cleaning
- Analyse two external sources of finance that DG could use to replace the company
Word Limit: 300 words
- Refer to Table 1. With the aid of appropriate calculations, recommend which of the two proposals DG should choose to increase
Word Limit: 450 words
Question A2
Michael’s Healthy Foods (MHF) is a private limited company which owns a food processing company in Bury, Greater Manchester. The company is owned by Michael and his wife, Charlotte. The company produces healthy snacks which they sell through specialist health food shops and other small independent food retailers throughout the North West of England. The company employs 10 production workers and 2 workers responsible for the packaging and dispatch of customer orders. These 12 employees are managed on a day-today basis by Michael. Charlotte is responsible for all other aspects of the day-today running of the business including ordering goods from suppliers, invoicing customers, marketing and paying employee wages.
MHF sources its ingredients from local farmers who grow their crops organically
i.e. without the use of harmful chemical fertilizers and pesticides. They have always been able to buy these at a good price because they pay cash on delivery. However, in recent months the price of these ingredients has been increasing. This has been partly due to the effect on supply of the very wet winter experienced in the UK and partly due to increased demand from other food producers and large supermarkets wanting to increase the range of organically grown produce they offer to customers. Supermarkets are able to offer similar products to its customers as those produced by MHF, but at much lower prices and this has reduced MHF’s sales.
Michael is worried about the effect the increase in ingredient prices and decrease in sales is going to have on profit margins. He outlined his concerns at a recent business meeting with Charlotte, where he also said, “Our margin of safety is going to be worryingly low compared to last year’s figure of 200,000 units”. Michael has produced the information in Table 1 to support his concerns.
Table 1: Sales and Financial Data for 2019 and 2020
| 2019 | 2020 (Forecast) | |
| Sales (Units) | 800,000 | 680,000 |
| Revenue (£) | 2,400,000 | 2,040,000 |
| Total variable costs (£) | 1,200,000 | 1,101,600 |
| Total fixed costs (£) | 900,000 | 900,000 |
| Profit for year (£) | 300,000 | 38,400 |
“I am more concerned about our cashflow than profits”, Charlotte said. “Look at the forecast cashflow I have produced for the next four months”, she continued. See Table 2 below showing forecasted cash flow.
Table 2: Forecast Cash Flow June – September 2020
| June | July | August | September | |
| Receipts from sales on credit | 150,000 | 150,000 | 160,000 | 160,000 |
| Cash sales | 5,000 | 5,000 | 6,000 | 6,000 |
| Net cash inflows | 155,000 | 155,000 | 166,000 | 166,000 |
| Payments to suppliers | 85,000 | 89,000 | 92,000 | 95,000 |
| Wages | 18,000 | 18,000 | 18,000 | 18,000 |
| Marketing | 5,000 | 5,000 | 5,000 | 5,000 |
| Factory Rent | 50,000 | 50,000 | ||
| Other expenses | 35,000 | 30,000 | 30,000 | 35,000 |
| Net cash outflow | 193,000 | 142,000 | 145,000 | 203,000 |
| Net cash flow | (38,000) | 13,000 | 21,000 | (37,000) |
| Opening balance | 32,000 | (6,000) | 7,000 | 28,000 |
| Closing balance | (6,000) | 7,000 | 28,000 | (9,000) |
- Using Table 1 and other information, calculate the change in MHF’s margin of safety between 2019 and 2020 forecast. You must show your working.
- Explain one advantage and one disadvantage of break-even analysis to MHF.
- Refer to Table 2. Discuss how MHF might improve its
Word Limit: 300 words
- Do you think Michael should be worried about the effect higher ingredient prices and lower sales are forecast to have on profit margins? Support your view with appropriate
Word Limit: 450 words
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