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Using the Cigar Box®

CB1: Profit calculations made easy

by Olivier van Lieshout

Global Facts

www.globalfacts.nl

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Contents

1. The five profit parameters

2. Using CB1

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Part 1

The five profit parameters

Learning objectives:

1. There are only five basic parameters.

2. But these have many components.

3. Know the difference between variable and fixed costs.

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Profit parameters

There are ONLY FIVE parameters P Price (per unit) VC Variable cost (per unit) q Quantity (in units per period) FC Fixed cost (per period) T Tax % of profit (per period)

Note: q, FC, T must always refer to the same period.

But…

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Profit parameters: Price

There are ONLY FIVE parameters, but…

with many components!

Price DDP Delivered, duties paid 20DDU Delivered, duties unpaid 18

CIF Cost, Insurance, Freight 18C&F Cost and Freight 17

DAF Delivered at Frontier 14FOB Free on Board 12

EXW Ex Works 10

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Profit parameters: VC & FC

There are ONLY FIVE parameters

but with many components!

VC

FC

VC1 Cost of raw material & ingredients, delivered factory

VC2 Cost of processing inputs into output: utilities, labor

VC3 Cost of packaging materials

FC1 Depreciation of fixed assets

FC2 Interests paid

FC3 Overhead (salaries, repair, transport, marketing…)

Where to obtain correct data ?

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Profit parameters: quantity

There are ONLY FIVE parameters

but with many components!

q = actual quantity sold per period

qCAP = quantity at full capacity utilization

quantity/hour * hours/day * days/year (harvest season)

3 ton/hour * 22 hours/day * 90 days/yr = 5940 ton/year

qBE = break-even quantity, where profit = 0

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Recognize costs - exercise

1. Ingredients

2. Road tax

3. Labels

4. Bank charges

5. Machine repair

6. Raw material transport

7. Depreciation

8. Social tax

9. Diesel for the boiler

10. Electricity in the factory

11. Electricity in the office

12. Casual labor

13. Management salary

14. Detergents and gloves

15. Interest on loans

16. Carton boxes

Are the following Variable or Fixed costs?

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Profit parameters (repetition)

There are ONLY FIVE parameters P Price (per unit) VC Variable cost (per unit) q Quantity (in units per period) FC Fixed cost (per period) Tax Tax % of profit (per period)

Not more!

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Part 2

Using CB1

Learning objectives: to be able to 1. fill in the Cigar Box with five parameters;2. analyze the results;3. see the importance of capacity utilization.

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CIGAR BOX 1 - Tomato paste 25 Brix, aseptic bags of 220 kg in steel drumsUSD USD

per ton per yearPrice (DDP Moscow) 1,000 Total Revenue 2,721,600 Import duties, 10% 100 Total Cost 2,554,377 Transport, sales commission 3% 144 Profit Before Tax 167,223 Price (EXW) 756 Profitability % 6%

Price (Raw Material, delivered factory) 71 Asset value 1,800,000 Processing ratio 6.0 Depreciation % 7.8%Raw Material cost 429 70% FC1 140,000 41%Other ingredients 12 2%VC1 441 72% Debt (40% of Asset value) 720,000

Interest rate 18.7%Production cost per hour (steam, electricity) 124 FC2 134,400 39%Production volume per hour (ton/hour) 2VC2 62 10% Number of FTE employed 15

Salaries staff incl. social taxes 50,000 15%Cost of packing (aseptic bag, drum) 21.8 Other overhead, repairs, maintenance 20,000 6%Number of drums per ton 4.5 FC3 70,000 20%VC3 99 16%

FC 344,400 100%FG losses % 2.0% FC % attributed to product 100.0%VC 614 100% FC (attributed to product) 344,400

Gross margin 142 Volume sold q (ton) 3,600 Gross margin % 19% Contribution 511,623

Variable cost 614 87% Break even volume (sales) 2,423 Break even volume (raw material) 21,600

Fixed Cost / q 96 13%Output capacity per hour in ton 2.0

Total Cost / q 710 100% Working hours per day 22 Length of harvesting season in days 110

Profit / q 46 Max. output capacity per year 4,840 Capacity utilization % 74.4%

Note: figures in blue are assumptions; figures in pink are calculated in another sheet; figures in black are formulas

P

VCFC

qcontribution

profit

P-VC

profit per unit

Break-even

Capacity Utilization

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Sales price P Sales Price = Amount per unit, INCO-term City. Tomato paste price = USD 1000 per ton, DDP Moscow. DDP = delivered, duties paid. Delivered to Moscow in this case. The import duties in Russia are 10% or USD 100 per ton. Transport and commission amount to USD 144 per ton. Hence the Price EXW = 1000-100-144 = USD 756 per ton.

USDper ton

Price (DDP Moscow) 1,000 100%Import duties, 10% 100 10%Transport, sales commission 3% 144 14%Price (EXW) 756 76%

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Variable cost VC

Three types of variable cost:

VC1, cost of everything which is consumed: raw

material and ingredients.

VC2, cost of processing raw material into the

finished product: energy, steam, casual labor,

detergents, diesel, gas.

VC3, cost of primary (jar, cap, label) and secondary

(carton box, shrink wrap, pallet) packing material.

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Raw material & ingredients VC1

The price of the raw material, delivered to the factory = 71/ton. The processing ratio is the quantity of raw material needed for

one unit of finished good. Here: 6 kg tomato for 1 kg of paste. Raw material cost = 71 * 6 = 429 The higher the losses, the higher the processing ratio, the more

costly the good. Calculate the cost of all other ingredients in the recipe: 12 VC1 = 429 + 12 = 441.

Price (Raw Material, delivered factory) 71Processing ratio (kg RM for 1 kg FG) 6.0Raw Material cost 429 70%Other ingredients 12 2%VC1 441 72%

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Processing costVC2 Calculating VC2 is not easy. Processing cost are calculated per hour. And divided by the production volume in units per hour. To arrive at the processing cost per unit. One must measure the use of steam, electricity, casual labor. Not just guess it! And measure the output per hour. Not just guess it! Get the correct data! After that, calculation is easy: 124 / 2 = 62

Production cost per hour (steam, electricity) 124 Production volume per hour (ton/hour) 2VC2 62 10%

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Packing costVC3

Packing cost are calculated per sales unit: 1 aseptic bag in 1 steel drum = 3.2 + 18.6 = 21.8;

Other examples of sales units: 24 bottles per carton = 24*(bottle + cap + label) + 1 box + 1 sticker; 10 sachets per bag = 10*sachet + 1 bag + 1 adhesive sticker

Calculate the number of sales units per unit of calculation: unit of calculation is ton = 1000 kg 4.4 drums of 225 kg per ton: 1000 / 225 = 4.4 add the packing losses, say 2.2%, multiply 4.4 by 102.2% = 4.5

VC3 = cost of packing * number of packs per unit = 21.8 * 4.5 = 99

Cost of packing (aseptic bag, drum) 21.8Number of drums per ton 4.5VC3 99 16%

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Total variable costVC

VC = VC1 + VC2 + VC3 Finished good losses

Warehouse losses, theft, pilferage, etc…. If there are 2% losses, enter 2% in FG losses % box.

VC = (VC1 + VC2 + VC3) * (1+ FG losses %) VC = (441 + 62 + 99) * 1.02 = 614

VC1 - Raw material & Ingredients 441 72%VC2 - Processing cost 62 10%VC3 - Primary & secondary packaging 99 16%

FG losses % 2.0%VC 614 100%

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MarginP–VC

Margin, or gross margin, is expressed per unit: Margin = P(EXW) – VC = 756 – 614 = 142

Price (EXW) 756 VC 614

Gross margin 142 Gross margin % 19%

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Margin %(P–VC) / P * 100%

Margin % = Margin / P(EXW) * 100% = 142 / 756 = 19% Margin % helps us to evaluate, if a margin is risky or not. Usual risk levels in food processing and manufacturing are:

Margin % Level Comment

<15% Very risky

Only acceptable when the production process parameters and all prices are fully under control.

15-25% Risky Only acceptable if production and price fluctuations are within 5-10% range.

25-35% Normal

35-45% Robust

45-70% Very robust

>70% Unlikely Check your calculations again!

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Contribution(P–VC) * q

The volume, or quantity sold is expressed in units per period. In this example, 3600 ton of tomato based are sold. Contribution is expressed per period: Contribution = Margin per unit * quantity per period =

= 142 * 3600 = 511,623

Gross margin 142 Volume sold q (ton) 3,600 Gross margin % 19% Contribution 511,623

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Fixed costs

Three types of fixed cost:

FC1, cost of investments: depreciation.

FC2, cost of debts: interest.

FC3, cost of all overheads. Salaries, social taxes, pensions, etc..

Repairs, maintenance

Office & transport cost

Marketing

Etc…..

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DepreciationFC1

Use a realistic value for the productive assets. For a tomato processing company this is about 1.8 million. Use a realistic depreciation rate. Here: the replacement period of the factory is 12.8 years. The depreciation = 1 / 12.8 * 100% = 7.8% FC1 = Asset value * depreciation % = 1,800,000 * 7.8% = 140,000

Asset value 1,800,000 Depreciation % 7.8%FC1 140,000 41%

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InterestFC2

Use the real amount of the debts, with a minimum of 40% of the asset value. For this company this is about 720,000 Use a realistic interest rate. Here: 18.7% per year. FC2 = Debt value * interest rate = 720,000 * 18.7% = 134,400

Debt (40% of Asset value) 720,000 Interest rate 18.7%FC2 134,400 39%

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OverheadFC3 Enter the number of full-time equivalent staff (FTE)

10 workers, working 6 months per year = 10 * 6/12 = 5 FTE 10 workers, working 4 months per year = 10 * 4/12 =

Calculate their salaries, incl. all taxes and emoluments: 50,000 Calculate one lump sum amount for all other overheads: 20,000 FC3 = salaries + all other overhead = 50,000 + 20,000 = 70,000

Number of FTE employed 15 Salaries staff incl. social taxes 50,000 15%Other overhead, repairs, maintenance 20,000 6%FC3 70,000 20%

3.3 FTE

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Total fixed costsFC

FC1 - depreciation 140,000 41%FC2 - interest 134,400 39%FC3 - overhead 70,000 20%

FC 344,400 100%FC % attributed to product 100.0%FC (attributed to product) 344,400

FC = FC1 + FC2 + FC3 FC = 140,000 + 134,400 + 70,000 = 344,400 The contribution of tomato paste must exceed these costs. In case more than 1 product is produced, FC must be shared. Calculate FC % attributed to product and enter in the box: 100% FC (attributed to product) = FC * FC % attributed to product

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ProfitTwo methods

Cost accounting method: Profit = Contribution – Fixed costs Bookkeeping method: Profit = Total revenues – Total costs Result is the same!

Cost accounting method USDper year

Contribution 511,623 Fixed costs 344,400 Profit before Tax 167,223

Total Revenue 2,721,600 Total Cost 2,554,377

Profitability % 6%

Contribution 511,623 Fixed costs 344,400

Bookkeeping method USDper year

Total Revenue 2,721,600 Total Cost 2,554,377 Profit before Tax 167,223 Profitability % 6%

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SummaryCost price

Cost price = total cost per unit

Variable Cost per unit (VC) 614 87%

Fixed Cost per unit (FC/q) 96 13%

Total Cost per unit (VC+FC/q) 710 100%

Price (EXW) 756

Profit per unit (P-VC-FC/q) 46 6%

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Break-even

Break-even point is where the profit is zero. Revenues – Cost = 0 or Contribution – Fixed cost = 0

Why calculating the break-even quantity? When Price, VC and FC are known and q is unknown

How many drums can be sold per year?

BE volume (sales) = minimum volume needed to sell to make a profit. BE volume (raw material) = minimum volume needed to process.

How much raw material do we need to buy?

Break even volume (sales) 2,423 Break even volume (raw material) 21,600

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Capacity

q = quantity sold = 3,600 tons of paste per year

qCAP = quantity produced at full capacity utilization

quantity/hour * hours/day * days/year (harvest season)

2 ton/hour * 22 hours/day * 110 days/yr = 4,840 ton/year

utilization = q / qCAP * 100% = 3,600 / 4,840 = 74.4%

Volume sold q (ton) 3,600

Output capacity per hour in ton 2.0 Working hours per day 22 Length of harvesting season in days 110Max. output capacity per year 4,840 Capacity utilization % 74.4%

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Capacity utilization

How does capacity utilization affect the Cost Price? the higher the utilization %, the higher the q (sales). the higher the q, the lower the FC/q, VC does not change, hence the lower the cost price.

How does capacity utilization affect the Profit? the higher the capacity utilization, the more the units sold and the lower the cost price, thus the higher the profit per unit. Profit = profit per unit * units sold At 74% utilization: = 46.5 * 3600 = 167,400 At 91% utilization: = 63.8 * 4400 (+22%) = 280,920 (+67%)

Conclusion: with 22% increase in sales volume, the profit increases by 67%!!

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Let’s practice!

Each person with own laptop.

Sample Cigar Boxes can be downloaded from

www.globalfacts.nl