GEZ Petrol Station

GEZ Bhd is the major oil company in Malaysia has conducted two main businesses, which is the fuel business and the convenience store business. Under the fuel business, the petrol stations sold Petrol Ron 95 (R95), Petrol Ron 97 (R97), and Diesel. Mr Aiman was as an Area Manager is responsible for directing the sales activities of more than twenty petrol stations in the northern region of Malaysia. They are having a difficulty to sustain in the business even though they are in the stable business segment and consistent in the long run.

This is due to the lack of knowledge in finance and costing which is it contributed to the business failure. There were disadvantages associated with a petrol station that is the fuel business had a very low profit margin. It was important that operators manage their cash collection very well. Realising the importance of management accounting concepts, Mr Aiman believed that the dealers and their relevant staff should have the knowledge in cost accounting.

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In order to collect data and build financial model, Mr Aiman has sought the advice from Rizal, a trained management accountant. To begin developing a CVP model, Rizal has gathered the necessary data from Baron Service Station (BSS) which is the busiest petrol station in the city. The petrol station had four pumps for petrol and one for diesel and the total number of nozzle was 20. The model that he would develop could be applied by petrol station operators of the same category. Regarding this case, from the cost-volume-profit analysis, Rizal can find that the breakeven point which is how much sales the petrol station of this type should generate from each of the fuel products and the Selesamart.

Mr. Aiman also can learn that the importance of differentiate between fixed cost and variable cost so that the petrol stations can sustain their profitable business and growth.

DATA ANALYSIS
1. How lucrative is the petrol station business?

To determine how lucrative is this business, we need to identified each
component with detailed calculation of the income statement which is does include all the revenue acquired, fixed cost and variable cost that related to the both type of the business. Firstly, we required to understand the definition of each component. Fixed costs are defined as expenses that remain more or less unchanged irrespective of the output level or sales revenue, within the relevant period. By definition, there are no fixed costs in the long run, because the long run is a sufficient period of time for all short-run fixed inputs to become variable. Variable costs are defined as expenses that vary depending on the output level or sales revenue of a company within the relevant period. Generally, as a business's output increases, variable costs also increase. The more products a business sells, the more money it spends on materials and manpower to produce those products. We categorized all the expenses into fixed and variable costs and calculate the net profits of Baron Service Station for year 2009.

REVENUE

VARIABLE COSTS

FIXED COSTS

INCOME STATEMENTS (Partial)

As describe in the Calculation stated above, the total contribution margin of Baron Service Station consists of two parts, which are fuel business and SelesaMart business. Total contribution margin is RM1,166,341.94. Contribution margin of SelesaMart business is about more and less 20% of the total contribution margin, which means that SelesaMart business is doing well, in addition, profit of SelesaMart will be higher if it doesn’t need to pay a 5% royalty to GEZ. From the income statement we can interpreted that this business in lucrative enough with a good control of expenses and Cost related to the operation, where BSS could generate Nett Profit of RM 772,825.94 (Calculation as per as Attachment 1)

2. Since the margin on fuel business is very low (6%) compared to convenience store (20%), do you agree that the convenience store is subsidizing the fuel business?

Firstly, the profit margin for fuel business is very low if compared to convenience store. The fuel business only gets about 6% of profit margin for year 2010.
Profit = Sales – cost
= 100% - 94%
= 6%
This is because GEZ Petrol only gain a few portion of profit from the sales of each litre of Ron 95, Ron 97 and Diesel. Below is the profit for each litre of fuel sold by GEZ Petrol Station and the profit margin for each type of fuel. Products

Price per litre
Cost per litre
Profit per litre
Profit margin (%)
Ron 95
RM1.80
RM1.6856
RM0.1144
6.36
Ron 97
RM2.05
RM1.9356
RM0.1144
5.58
Diesel
RM1.80
RM1.7388
RM0.0612
3.40

Besides that, the petrol station also cannot increase the price even though the government increase the price of fuel. In the short run, the margin per litre would remain the same. For example, if the government announced there
would be a 40 cents increase in the price per litre, then, operators also have to pay 40 cents higher. So, the profit margin will not increase.

Products

Price per litre
Cost per litre
Profit per litre
Profit margin (%)
Ron 95
RM2.20
RM2.0856
RM0.1144
5.20
Ron 97
RM2.45
RM2.3356
RM0.1144
4.67
Diesel
RM2.20
RM2.1388
RM0.0612
2.78

From the above calculation, it shows that the profit margin will not increase due to increase in price.  Although the profit margin for fuel business is lower than profit margin for convenience store, but the revenue gain from fuel business is far better than convenience store. For example, from the monthly average sales of RM 1.7 million; where the large portion of this amount is come from fuel business (RM 1.6 million from the revenue), while only RM 0.1 million comes from convenience store. In addition, in year 2009, the sales revenue of the petrol station is RM 20,682,189.60 and about RM 19,251,897,60 of the amount comes from fuel business; which is approximately 93.08% (RM 19,251,897,60/ RM 20,682,189.60) of the revenue. While, only 6.92% (RM 1,430,292/ RM 20,682,189.60) comes from convenience stores. So, in this situation, it show that the fuel business itself are able to sustain the business of petrol station even without convenience store because the convenience store only contributed a little portion of their income.

Other than that, most of the customers who come to petrol station are to refuel rather than shop at the convenience store. Only a few customers will buy at their convenience store because if someone wants to buy foods or other daily needs, they will prefer supermarket as they have more choices compare to convenience store. So, large portion of revenues or income that flow into the company is from the sales of Ron 95, Ron 97 and Diesel. Even though the profit margin for fuel business is small but the revenue is far better compared to convenience stores. Therefore, the convenience store is not subsidising the fuel business instead both fuel business and convenience store had contributed to sustainability of GEZ Petrol Station.

3. If the government raised the RON95 price to RM2.10, do you anticipate the profitability of the business will be eroded?

If the government raised the Ron 95 price to RM 2.1 per litre, the profitability of business will be affected significantly. The changes of RON95 price from RM1.80 to RM2.10 per litre has incremental price of RM 0.3 per litre. In parallel, cost per litre of Ron 95 also will increase RM 0.2788 from RM 1.6856 to RM 1.9644 per litre due to estimation of cost on price proportion of 93.64%. Total Net profit for RM 1.8 (Ron 95) is RM 766,706.02 and had increase to RM 924,046.16 when Ron 95 price increased to RM 2.1. Net profit margin had increase from 3.71% to 3.98%. For Break- even Analysis, the increase of Ron95 price has indicate a better result which only required 3187559.208 litres/ RM 6,936,231.66 compared to 3618188.562 litres/ RM 7,015,784.34 to achieve zero profit. In overall, rise of Ron95 price by government will benefit GEZ petro station’s financial performance. It has higher profitability and capable to achieve Break Even Point with a lower output level compared to previous price which RM 1.8 per litre for Ron 95. Below are the changes of GEZ financial performance if Ron95 price changed.

RON95 (79%)

**Assuming the portion of fixed cost between Fuel business and Selesa Mart is based on the average sales of 2009 Price per litre
RM1.80

Total Fixed Cost (RON95)

Portion between fuel business and Selesa
Salaries
RM195,720.02

= 1.6/1.7 =94.12%

Utility Cost
RM35,550.00

94.12% of amount in fixed cost for fuel business
Rental
RM5,487.38

5.88% of amount in fixed cost for Selesa Mart
Insurance Premium
RM1,427.61

Stationeries
RM1,784.52

Total Fixed Cost
RM239,969.53

RON 95

Fixed Cost -Salaries

Amount
Salary(RM)
Total per year
Portion
Fixed cost- Salaries
Station Manager

1
3206
38472
0.9412*0.79
28605.78
Supervisor

1
1674
20088
0.79
15869.52
Cashier
3
950
34200
0.79
27018
Crew
12
812
116928
0.79
92373.12
Clerk
1
960
11520
0.9412*0.79
8565.67
General Worker

2
805
19320
0.9412*0.79
14365.35
Security Guard

1
1000
12000
0.9412*0.79
8922.58
Total
195720.02

Input changed: (Exhibit 3)

Original Price

New Price

4. If a credit card sale is reduced from 40% to 20%, what is the effect on overall profitability?

Nowadays more and more people are using credit card in their daily life. People prefer credit cards because they are convenient to use and it is easier to take them instead of carrying a lot of cash. And if wallet or purse is stolen, we can simply call the creditor and close the credit card account before anyone uses the card. In GEZ petrol station, petrol operators had to face was the increasing cost of credit card fees paid to bank as more and more of their customers were starting using credits cards. When a driver pays for gas with a credit card, GEZ petrol station must pay an average 1% of the sales price to the bank to process the payments.

GEZ petrol station have accounted that the credit card sales are almost 40% of their total sales. Research are made to the Baron Service Stations ( BSS) , a petrol station that was located in a city, in the northern region of Malaysia. It was one of the busiest petrol stations in the city. In year 2009, BSS generated sales revenue of RM 19,251,897.60, 40% of the revenue RM 7,700,759.04 was come from credit card sales and the bank will charge RM 77007.59 from the credit card sales. Those fees are so high, it already slim profit margins and made it hard for stations to make money on gas sales. Otherwise when the credit card sales is reduce to 20% of the revenue RM 3,850,379.52 was come from credit card sales and the bank will charge RM 3,850,3.80 from the credit card sales. For details as below:

Credit Card Fees (40%)

Product
Sales (Litres)
Price/Litres
Total Revenues
Ron 95
8,459,604.00
1.80
15,227,287.20
Ron 97
174,576.00
2.05
357,880.80
Diesel
2,037,072.00
1.80
3,666,729.60

19,251,897.60
Usage of Credit Card

40%

7,700,759.04
Credit Card Fees Charges

1%
Credit Card Fees

77,007.59

Credit Card Fees (20%)

Product
Sales (Litres)
Price/Litres
Total Revenues
Ron 95
8,459,604.00
1.80
15,227,287.20
Ron 97
174,576.00
2.05
357,880.80
Diesel
2,037,072.00
1.80
3,666,729.60

19,251,897.60
Usage of Credit Card

20%

3,850,379.52
Credit Card Fees Charges

1%
Credit Card Fees

38,503.80

Baron Service Station

Partial of Income Statement for Year Ended 2009 (20%)
Fuel Business
Selesa Mart

Revenue
19,251,897.60
Revenue
1,430,292.00
(-) Variable Cost

Raw Material Cost
18,139,478.60

Evaporation Losses
83,613.27
COGS
1,144,233.60
Credit Card Fees
38,503.80
Royalty
71,514.60
Contribution Margin
990,301.93
Contribution Margin
214,543.80

Total Contribution Margin

1,204,845.73
(-) Fixed Cost

393,516.00
Nett Profit

811,329.73

Based on the calculation above, when the credit card sales been adjusted from 40% to 20% it will affect the overall profitability of the company. The income statement showed the increase of net profit from RM 772,825.94 to RM 811,329.73 of RM 38,503.79.When the credit card sales decrease, a 1% fees was charged by the banks also will reduce and this effect the variable cost for the company from before change cost is RM 18,300,099.46 to after change cost of RM 18,261,595.67. The difference between both of the cost and company managed to save is RM 38,503.79.

The increasing of the amount in using credit card to make payment in the petrol station will also increase the cost of credit card fees that need to pay to banks, indirectly it will give effect to the profitability of the station. The profit of the station will decrease due to the increasing of cost. If increasing of customers chooses to make payment by cash instead of credit card, then the profitability of the petrol station will increases, because the extra cost on the credit card sales that they bear will be reduce. To cover the problem, petrol stations can shift the cost of credit card charge by charges back the customer when they use cards. However petrol stations need to take risk that they maybe will losing customer. Customer maybe will decide to change to other petrol stations that do not have any charge when they use credit card to make payment. Petrol station also can offer a cash-only discount. This may attract more customer make payment by using cash.

5. What is the appropriate basis to allocate the cashier cost between four products Ron 95, Ron 97, diesel and SelesaMart?

To assign the costs of products, we use cost allocation as it is a tool that can helps manager to track the cost that associated more efficient. Costs are allocated to obtain desired motivation because it sometimes made to influence management behaviour and thus promote goal congruence and managerial effort. Instead, it is used to compute income and asset valuations and to justify costs or obtain reimbursement because sometimes prices are based directly on costs, or it may be necessary to justify an accepted bid. From the information given in the case, GEZ petrol station conducted two main business which is the fuel business and the convenience store business, known as SelesaMart. Since GEZ provide joint provide, thus the appropriate basis is sales value at split-off point. The table shown below is the summary of monthly average sales.

PRODUCTS

SALES PROPORTION
AMOUNT
Fuel Business
94.12%
RM 1,600,000
Petrol Ron 95
79%
RM 1,264,000
Petrol Ron 97
2%
RM 32,000
Diesel
19%
RM 304,000
SelesaMart
5.88%
RM 100,000
AVERAGE SALES (monthly)
100%
RM 1, 700,000
Table 5.1 Monthly average sales in 2009
The total monthly average sales given is RM 1,700,000 with RM 1,600,000 was generated from the fuel business and the remaining from SelesaMart which in RM100,000. The highest contribution in fuel business in Petrol Ron 95 with RM 1,264,000 and follow with Diesel which is RM 304,000 then Petrol Ron 97 with RM 32,000. Then, we need to calculate total revenue for R95, R97, Diesel and Selesamart. Thus we multiply sales per litre with price per litre to get the amount of revenue. As stated in the case the sales revenue that BSS generated is RM20,682,189.60 that are comprise RM19,251,897.60 of fuel sales and RM1,430,292 of SelesaMart sales.

The calculation can be summarizes as the table shown below :

R95
R97
Diesel
SelesaMart
Sales (Litres)
8,459,604
174,576
2,037,072
-
Price per litre (RM)
1.80
2.05
1.80
-
Revenue
RM15,227,287.20
RM357,880.80
RM3,666,729.60
RM1,430,292.00
Percentage (%)
73.63%
1.73%
17.73%
6.92%
Table 5.2 Total revenue and percentage

For BSS, they can allocate more cost to Petrol Ron 95 since it contribute the highest revenue which is RM 15,277,287.20 continue with Diesel with RM 3,666,729.60. For Petrol Ron 97 and SalesaMart, BSS can allocate less cost since it contributed only RM357,880.80 and RM1,430,292. In BSS there were two cashiers working at the sales counter. One will concentrate on the fuel transactions, and one for the shop, even though they handle both transactions at times and overall there were 6 cashiers working for BSS. Monthly salary per person for the cashier is RM950. So BSS shall pay RM5,700 to their 6 cashiers and RM68, 400 in annually. The appropriate basis to allocate the cashier cost between the four products RON95, RON97, diesel and SelesaMart is we calculated the revenue for the four products and we divided with the total sales to find the percentage for each products. So the percentage for product RON95 is 73.63%, RON97 is 1.73%, diesel is 17.73% and SelesaMart with 6.92%.

The total revenue for Petrol Ron 95, Petrol Ron 97, Diesel and SelesaMart is RM20, 682,189.60. After we find the percentage, we calculated the cashier cost for each product. To find the cashier cost, we multiple the percentage with the total annual salary for the cashier which is RM 68,400(RM 950 x 6 x 12). The result is, for the product RON95 the cashier cost is RM50, 359.58 followed by RON97 is RM1, 183.58, diesel is RM12, 126.58 and SelesaMart is RM4, 730.25. The total cashier cost is RM68, 400. The calculations can be summarize as shown in table below :

R95
R97
Diesel
SelesaMart
Percentage (%)
73.63%
1.73%
17.73%
6.92%
Cashier Cost
RM50,359.58
RM1,183.58
RM12,126.58
RM4,730.25
Table 5.3 Percentage and cashier cost

The choice of method for allocating common costs should depend on the ease of application, the perceived quality of information reported to external parties, and the perceived fairness of the allocation when multiple product managers are responsible for joint products. However, as discussed above, the allocation of common costs is arbitrary, and no method is conceptually preferable to any other method. All methods of allocating common costs across joint products are generally useless for operational, marketing, and product pricing decisions.

6. Is utility cost fixed or variable? What difference does it make to the breakeven point of Ron 95 if it is classified as i) fixed cost, and ii) variable cost? In our opinion utility cost is fixed cost. This is because, the cost will be relatively the same as it was used for all the time. This cost wont effect the unit sold even though it not used.

Utility cost as FC
Utility cost as VC
BEP (RM)
5,024,702.71
4,154,075.59

BEP (UNIT)
2,791,501.50

2,307,819.77

If the utility is fixed cost, the Break Even Point in RM is higher compare to the utility cost as variable cost. Same goes to the Break Even Point in Unit, which is the utility as fixed cost is higher compare to the utility as variable cost.

CONCLUSION

Regarding this case, from the cost-volume-profit analysis, Rizal can find that the breakeven point which is how much sales the petrol station of this type should generate from each of the fuel products and the Selesamart. Mr. Aiman also can learn that the importance of differentiate between fixed cost and variable cost so that the petrol stations can sustain their profitable business and growth. If the utility is fixed cost, the Break Even Point in RM is higher compare to the utility cost as variable cost which is RM5,024,702.71 compared to RM4,154,075.59 . Same goes to the Break Even Point in Unit, which is the utility as fixed cost is higher , 2,791,501.50 compare to the utility as variable cost 2,307,819.77 To assign the costs of products, we use cost allocation as it is a tool that can helps manager to track the cost that associated more efficient.

Costs are allocated to obtain desired motivation because it sometimes made to influence management behaviour and thus promote goal congruence and managerial effort. Instead, it is used to compute income and asset valuations and to justify costs or obtain reimbursement because sometimes prices are based directly on costs, or it may be necessary to justify an accepted bid. From the information given in the case, GEZ petrol station conducted two main business which is the fuel business and the convenience store business, known as SelesaMart. Since GEZ provide joint provide, thus the appropriate basis is sales value at split-off point