Margin and Breakeven Analysis Simulation Paper

Running head: MARGIN AND BREAKEVEN ANALYSIS SIMULATION

Contribution Margin and Breakeven Analysis Simulation

University of Phoenix

Fin/540

Professor Neil David

May 4, 2005

Contribution Margin and Breakeven Analysis Simulation

When Maria was considering a large bulk order, how should she use the concept of contribution margin to decide which cookie's production to reduce in order to free up enough capacity to accept the bulk order? Under what circumstances should she not have accepted the bulk order? In the simulation Maria should use the contribution margin method when sales revenue less variable costs. It is the amount available to pay for fixed costs and provide any profit after variable cost has paid. Maria suggested that the total contribution Margin as well as the operating profits from lemon crиme cookies is less than that for real mint cookies. Therefore reduce the current production volume for lemon crиme cookies and produce more real mint cookies to accommodate this bulk order.However, Maria decision what not so conducive. When a company maximizes operating profits it is better to produce more of the product that has a greater contribution margin per-unit like the lemon cookie. In the beginning of the simulation Maria felt that price reduction alone was not sufficient. Aunt Connie's Cookies had to establish that they were one of the favorites in the convenience food category. It was best that Aunt Connie's Cookies increase their ad expenses by half for both peanut butter and lemon cookies. The company would then reach out to more retailers in the metros. To achieve this, they must pay more to their distributors $0.10 per pack instead of $0.06 per pack. Retaining the unit prices and increasing Aunt Connies Cookie's marketing expenditure resulted in good profits for the company. However, reducing unit prices could have boosted sales and resulted in even better profits. The bulk order should have not been excepted if the volume production levels were not reduced and when the contribution margin per pack for real mint cookies from the bulk order is less than the current contribution margin profits this situation could cause Aunt Annie's Cookies to create a deficit.

What should Maria have done if the breakeven volume of lemon crиme cookies in this new plant were 650,000 packs and continuing to make peanut butter cookies would not have been profitable? If the company decides to buy the unit and continue making peanut butter cookies it would have suffered a great loss because the company had big problems with manufactures and unskilled workers. Maria should have continued to make more lemon crиme cookies. According to their sales forecast they needed to produce 1.6 million packs of lemon cookies. The breakeven point for manufacturing lemon crиme cookies in the newly acquired unit is 563,000 packs. Maria should have chose to manufacture 600,000 packs resulting in operating profits from the new unit this will make the exact monthly production target for the lemon crиme cookies and increase overall profit. Increasing the operating profits packs to 650,000 would result forcing the existing unit to reduce volumes for lemon cookies as they were exceeding the monthly production target. Since the variable cost per unit for making the lemon crиme cookies is higher in the new unit and higher that the peanut nut butter cookies. This decision will led to a reduction in overall profits.The most important concepts in the simulation is fixed cost, variable cost, and break-even analysis and contribution margin.

The most important concept is break-even analysis. This determines the point at which your business begins making a profit.

Break-even analysis

Break-even analysis is particularly important in the planning stages of a business. It shows what sales and fees you need to make on a daily, weekly or monthly basis, in order to pay all your expenses.

To put together a break-even analysis, you must first separate variable costs from fixed costs. Fixed costs are predictable on a monthly basis, and occur whether or not you are open for business, while variable costs change according to your business operations, such as the cost of your supplies, material or labour.

VARIABLE COSTS are those costs which vary in direct proportion to a change in some activity level. For example, direct material is ordinarily a variable cost. Each additional unit produced requires another unit of direct material cost.

In contrast, FIXED COSTS remain constant in total as changes occur in the activity level. Over a relevant range of activity, fixed costs will not change. For example, the insurance cost on the factory building is probably the same regardless of the level of production.

The contribution margin is a cost accounting concept calculated as total revenue from a product or service less the total variable cost.

The contribution margin helps you make better decisions about pricing, adding or subtracting from a product line, how to structure sales commissions, among other things.

Business Wire article explains the