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Betis Limited is considering changing the way it is structured by asking its employed staff to
become freelance. Employees are currently paid a fixed salary of $240,000 per annum, but
would instead be paid $200 per working day. On a typical working day, staff can produce
40 units. Other fixed costs are $400,000 pa.
The selling price of a unit is $60 and material costs are $20 per unit.What will be the effect of the change on the breakeven point of the business and the
level of operating risk?– The answer is BE reduces by 4,571 units and operating risk goes down.
– I have have obtained the answer for BE but my issue is that why and how why operating risk goes down.
-In the answer it says, Operating risk reduces with less fixed costs in a business.
– The business may obtained less fixed cost but it is also loosing contribution. Therefore the either the risk is neutral or the risks is high due to the fact that it is making less contribution.Could you please clarify this?
Thanks.
It is because the fixed costs are lower.
The greater the fixed costs are, then the more the profit will go up and down in % terms if the sales go up and down, and therefore the more the risk.
I am a bit confused here. The business may have a reduction in fixed cost but at the same time it is also experiencing a reduction in contribution(form $40 to $35) .
Could this decrease in contribution be a factor that in decreasing the overall profit? Because at the end, a reduction in contribution could be a factor that creates difficulties covering the fixed costs (although there has been a reduction in FC). Therefore this could be a risk!
Could you please clarify?
Thanks.
If profit in the future is certain, then there is no risk. If profit however might be higher or might be lower, then the more higher or lower it might be then the greater the risk.
Suppose at the moment sales revenue is 100, variable costs are 40 and fixed costs are 20. Then the profit is 40.
Suppose sales volume increases by 10%. The revenue will go up to 110, the variable costs will go up to 44, and the fixed costs will stay at 20. So the profit will go up from 40 to 46, which is an increase of 6/40 = 15%
Suppose sales volume falls by 10%. The revenue will down to 90, the variable costs will go down to 36, and the fixed costs will stay at 20. So the profit will go down from 40 to 34, which is a fall of 6/40 = 15%.Suppose instead that at the moment revenue is 100, variable costs are 50 and fixed costs are 10. The current profit is therefore again 40.
However repeat the workings above for sales volume increasing or decreasing by 10% and you will find that the profit increases or decreases by only 12.5% instead of 15%.The fact that it does up and down by a smaller % means things are less risky.
How can we calculate the reduction in BE by 4571 units. fixed cost before the change is 640,000$ , what is the fixed cost after that?
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