Marginal costing is a traditional financial technique which is used by companies for short term decision making within the music & entertainment industry. The concept of marginal costing is concerned with the treatment of fixed costs and the relationship that exists between sales, variable costs and contribution. This technique is often used by record labels to estimate the costs which they will incur & profits they will earn per unit which is manufactured and sold. Cost behaviour – we need to understand how costs behave at different levels of activity so that we can determine what costs should have been for a trading period and estimate costs for a future period. Cost behaviour studies the way that costs fluctuate. Two major influences on costs are volume (activity) and time. There are three types of cost: variable, fixed & semi-variable. Variable costs are those which change with the level of output or activity. For instance, if a major record label has manufactured 100,000 CD’s for a pop artist’s new album which is going to be released. The bigger the quantity of CDs sold, the higher the amount of money the artist will receive as royalties. So, if the artist is under a 12% (true artist royalty) therefore receives £0.76p per CD sold. If only 50,000 CDs are sold at a Published Dealer Price of £7.50 they would receive £38,000 in royalties. Whereas, if they managed to sell 100,000 CD’s instead they would receive £76,000. As you can see the artist royalty increases as the sales (activity) increases.
Fixed costs are those which remain constant despite changes in output or activity; however they can change over a period of time. For instance, if a record label signed an artist and offered an advance of £40,000 this figure would remain fixed. Despite changes in sales & expenditure, there is still no change to the advance.
Semi-variable costs are those which have both a fixed & variable element. For instance, if you have manufactured 100,000 CDs for £0.50p per unit, brings the cost of production to £50,000. This cost remains fixed. Suddenly there is a lot of demand for the CDs but all of the CDs have been sold, so it is decided to manufacture 50,000 more CDs therefore the cost raises due to demand to a total of £75,000.
Contribution is the difference between sales and variable costs in the marginal cost equation. This is the contribution towards fixed costs and profit. To calculate what the contribution is you take the selling price per unit and minus the variable costs from it (see example below). Selling price per unit = £10
Minus Variable costs = £3
Contribution per unit = £7
Breakeven analysis uses the same concept as marginal costing to calculate an estimated figure of how many units of a product need to be sold to cover all costs (this is also known as the breakeven point). Breakeven analysis is used for various purposes including: before starting up a business to create a business plan, to make changes to a business, to measure profits and losses, to evaluate alternative methods of production. To calculate the breakeven point we need to know the: selling price, costs of product/service, variable costs per unit, overhead costs and whether they are fixed or variable. We also need to know if there are any limitations. As a minimum, the sales need to be equal to the figure of your fixed costs to make sure that you are not losing any money. For instance, if fixed costs are £2500 per month, you would have to sell at least 357 units to ensure you break-even.
£2500 (fixed costs) ÷ £7 (contribution per unit) = 357.1428571428571 (rounded down to 357 units) Once the break-even point has been reached any additional contribution from sales will be pure profit. For instance, if one month 500 units were sold, total contribution would be £3,500 which would cover the £2500 fixed costs and then you are left over with £1000 profit. Break even analysis can also be used to work out how many units...
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