Assignment Group 4 Semester Spring Year 2020 Course Title

assignment Group 4semester Spring Year 2020course Title

Determine how many pizzas Gary’s Pizza must sell to break even and to earn a target profit, and calculate the safety margin based on budgeted sales. Additionally, explain how a product with a negative contribution margin can arise and whether it should be continued.

Paper For Above instruction

Gary’s Pizza operates with a focus on delivering pizzas to residences and apartments near a major state university. As with many small businesses, understanding the financial metrics such as break-even point, target profit levels, and safety margins is crucial to effective management and strategic decision-making. This paper explores these concepts in relation to Gary’s Pizza, applies relevant financial formulas, and discusses implications for product management, particularly in the context of a product with a negative contribution margin.

Introduction

Financial management within small and medium-sized enterprises (SMEs) heavily relies on the ability to analyze costs, revenues, and profitability effectively. The contribution margin approach is a fundamental aspect that helps managers determine profitability on a per-unit basis, and thereby make informed decisions about pricing, production levels, and product offerings. This paper examines the specific case of Gary’s Pizza, aiming to compute the break-even sales volume, targeted profit sales, and interpret safety margins. Additionally, it investigates the case of a product with a negative contribution margin, a scenario that raises critical strategic questions about product viability and business sustainability.

Break-Even Analysis

The break-even point (BEP) is the level of sales at which total revenues equal total costs, resulting in neither profit nor loss. For Gary's Pizza, the fixed costs are $72,000 annually, with an average sales price per pizza of $18. and a variable cost per pizza of $6. To compute the break-even quantity, we use the formula:

BEP (units) = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)

Substituting the given values:

BEP = $72,000 / ($18 - $6) = $72,000 / $12 = 6,000 pizzas

Therefore, Gary’s Pizza must sell 6,000 pizzas annually to cover all costs and break even.

Target Profit Sales Level

To determine the number of pizzas required to attain a target profit of $54,000, we modify the break-even formula by adding the target profit to fixed costs:

Sales (units) = (Fixed Costs + Target Profit) / Contribution Margin per Unit

Contribution margin per pizza is:

$18 - $6 = $12

Calculating the required sales:

Sales = ($72,000 + $54,000) / $12 = $126,000 / $12 = 10,500 pizzas

This means Gary’s Pizza needs to sell 10,500 pizzas annually to achieve a profit of $54,000.

Safety Margin Calculation

The safety margin indicates how much sales can fall before reaching the break-even point. It is calculated as the difference between actual or budgeted sales and the break-even sales, expressed in dollars:

Safety Margin ($) = (Budgeted Sales - Break-Even Sales) x Selling Price per Unit

Given budgeted sales total 8,500 pizzas:

Safety Margin = (8,500 - 6,000) x $18 = 2,500 x $18 = $45,000

Thus, the company's safety margin in dollars is $45,000. This shows the buffer available before sales fall below the break-even level, providing financial security against unforeseen sales declines.

Product with a Negative Contribution Margin

ABC Corporation’s product code A132 has a negative contribution margin, which indicates that the variable costs associated with producing and selling this product exceed its selling price. This situation can arise due to several reasons: incorrect cost estimation, pricing strategies that are outdated, or an uncompetitive product market.

Specifically, a negative contribution margin could result from:

  • High variable costs due to inefficiencies or supply chain issues.
  • Low pricing power stemming from intense competition or market saturation.
  • New products with initial high costs and low sales volume.

Such a scenario suggests that each sale of the product reduces overall profit, which makes its continued stocking questionable. Generally, if a product consistently yields a negative contribution margin, it destroys value for the firm and should be reviewed critically.

The company must consider whether strategic reasons justify keeping the product, such as drawing customers who might purchase other profitable items or fulfilling contractual obligations. However, in most cases, discontinuing or restructuring the product to improve its contribution margin is advisable to optimize profitability and resource allocation.

Conclusion

Effective financial decision-making necessitates a clear understanding of key metrics such as break-even point, target profit levels, and safety margins. For Gary’s Pizza, these calculations reveal that 6,000 pizzas per year are needed to break even, while sales of 10,500 pizzas are necessary to reach a profit target of $54,000. The safety margin, calculated at $45,000, provides a cushion against sales fluctuations. Concerning ABC Corporation’s negatively contributing product, a negative contribution margin signals poor profitability, and the firm must decide whether to improve the product’s cost structure, price it differently, or eliminate it. Strategic analysis of these financial metrics enables businesses to align operational activities with long-term profitability and competitiveness.

References

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