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Break-Even Presented by Steve LeFever, Chairman Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 [email protected] www.profitmastery.net

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Page 1: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

����������� ���Break-Even ���

��������������������������������� ���������������������� �����������!����

Presented by Steve LeFever, Chairman

Profit Mastery

Business Resource Services Inc. 200 First Avenue West �� Suite 301 � Seattle, Washington 98119 Phone 206-284-5102 � [email protected] � www.profitmastery.net

Page 2: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Assets = Liabilities + Net WorthSales

Balance Sheet

Efficiency

Income Statement

� To pay for new assets� To pay off debt� To pay out to the owners

Net Profit

Uses of Profits:

Net Profits Cash Flow

What�Gets�Measured...Gets�Managed�

���������Profit�Mastery®

Financial�Performance�is�a�three�legged�stool�

� Education�–�establishing�the�foundation

� Benchmarking�–�creating�the�yardstick

� Performance�Groups�–�providing�theaccountability�and�discipline

Financial�Operating�Cycle�

©2015 BRS 1

Page 3: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Seven�Steps�to�Business�Success�

1. Plan�properly�before�start�up

2. Monitor�financial�position

3. Understand�the�relationship�betweenprice,�volume,�and�costs�

4. Manage�cash�flow

5. Manage�growth

6. Borrow�properly

7. Plan�for�transition

©2015 BRS 2

Page 4: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Income�Statement�ManagementKnowing�Your�Costs�

DEFINITION�..........�Managing�the�income�statement�implies��managing��the�relationship�between�costs,�volume�and�pricing.��Break�even�analysis�is�the�tool�that�lets�owners��and��managers�gauge�the�results�of�changes�in�costs�or�pricing.�

REVIEW�...............�We�have�completed�the�section�on�financial�statement�analysis,�which�gives�us�a�picture�of�the�past.��With�break�even�analysis,�we�have�a�method�to�analyze�the�present.�

IMPACT�...............�Break�even�analysis�focuses�attention�on�two�kinds�of�costs����fixed�costs�and�variable�costs����and�how�changes�in�either�affect�profits.��The�analysis�answers�questions�such�as:��“Will�a�decrease�in�price�produce�more�sales?”�

RESULTS�..............�Using�the�break�even�tool,�we�will�be�able�to�relate�changes�in�costs�and/or�changes�in�pricing�to�the�corresponding�changes�that�are�required�in�sales�volume�if�a�given�level�of�profit�is�to�be�maintained.�

The�Goal:�

Calculating�the�sales�required�to�incur�no�profit,�but�no�loss�""�and�to�evaluate�the�impact�of�changes�in�costs�on�

the�selling�price"cost"volume�relationship.�

The�Tools:�

Break���Even��Analysis�Break���Even��Proofs�Expansion��Analysis�

©2015 BRS 3

Page 5: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Key�Terms

Break"Even�....................................... To�have�no�profit�and�no�loss;�the�point�at�which�revenues�exactly�cover�expenses.�

Variable�Costs�.................................. Expenses�that�vary�directly�with�sales;�those�costs�that�are�incurred�only�if�sales�are�made.�

Variable�Cost�Percentage�................ The�percent�of�each�dollar�of�sales�that�goes�to�cover�variable�costs.�

Fixed�Costs�....................................... Expenses�that�do�not�vary�with�sales;�those�costs�that�are�incurred�whether�or�not�any�sales�are�made.�

Contribution�Margin�........................ The�amount�left�after�variable�costs�are�paid.����The�amount�that�is�left�to�contribute�to�covering�fixed�costs�(and�profits).�

Contribution�Margin�Percentage�.... The�percent�of�each�dollar�of�sales�that�is�left�after�the�variable�cost�percentage�has�been�deducted;�the�amount�from�each�dollar�of�sales�that�is�contributed�to�cover�fixed�costs�and�profits.�

Target�Profit�..................................... The�amount�of�profit�that�is�planned.��The�profit�that�is�added�to�fixed�costs�to�determine�the�sales�goals����in�relation�to�a�given�contribution�margin.�

©2015 BRS 4

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Break"Even���(as�explained�by�your�college�professor)�

Costs�

Sales�

Break"Even�4"Step�Process�

1. Classify�expenses�as�variable�or�fixed

2. Determine�Variable�Cost�Percentage

3. Determine�Contribution�Margin�Percentage

4. Calculate�Break�Even�in�dollars

©2015 BRS 5

Page 7: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

How�Do�Fixed�Costs�Behave?�

How�Do�Variable�Costs�Behave?�

©2015 BRS 6

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Understanding�Contribution�Margin�

���

��������

With�Net�Profit�at�0,�you�are�at�Break"Even�

What�Types�of�Questions��Can�Break"Even�Answer?�

1. If�I�cut�or�add�a�fixed�cost�how�will�it�impact�the��volumeof�sales�I�need�to�Break�Even?

2. If�I�lower�prices�how�will�it�impact�Break�Even?

3. If�I�raise�prices�how�will�it�impact�Break�Even?

Sales�- COGS�- Gross�Profit�- OE�

Net�Profit�

Sales��V�C�What’s�Left���F�C�Net�Profit�

Contribution�Margin�

©2015 BRS 7

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Steve’s�Pen�Company�

©2015 BRS 8

Page 10: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Sales

VariableCostCup

FixedCostCup

NetProfitCup

Contribution Margin

The�Cup�Theory��The�Concept�of�Contribution�Margin�

©2015 BRS 9

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Target�a�Profit�

You�want�to�have�a�profit�of�$200,000�at�the�end�of�the�fiscal�year.���

What�do�you�need�in�increased�sales�to�insure�this�level�of�profit?�

Fixed�Costs�=�$800,000�(FC)�

Targeted�Profits�=�$200,000�(TP)�

Total�FC�+�TP�=�$1,000,000�

©2015 BRS 10

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Sales

VariableCostCup

FixedCostCup

NetProfitCup

Contribution Margin

Four�Ways�to�Increase�Profits�

1.���

2.���

3.���

4.���

What’s�the�strategic�management�value�of�this�picture?�

©2015 BRS 11

Page 13: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Break"even�Case�Study�"�Dollars�Lake’s�Pharmacy�Practice�Example�

Two�years�ago�Brad�and�René�wanted�to�figure�their�break�even�sales�volume,�so�they�went�through�their�most�recent�income�statement�and�classified�and�totaled�each�category.��Here's�what�they�got:�

Variable�Cost:�..................�$1,275,000�

Fixed�Cost:�..........................�$357,000�

His�Sales�were:�

Sales�................................�$1,700,000�

1. What�were�break�even�sales�for�Lake’s?��Use�your�break�even�worksheet�to�do�thecalculations.

©2015 BRS 12

Page 14: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Break"even�Case�Study�"�Dollars�Lake’s�Pharmacy�

You�have�been�called�in�to�provide�some�assistance�to�Lake’s.��They�have�already�gone�through�their�most�recent�income�statement�and�classified�costs�into�fixed�and�variable.��Here�is�what�they�came�up�with:�

Variable�Cost:�..................�$1,986,700�

Fixed�Cost:�..........................�$490,800�

Lake’s�sales�were:�

Sales�................................�$2,500,000�

Your�job�now�is�to�calculate�their�variable�cost�percentage,�their�contribution�margin,�and�his�break�even�sales�point;�then�answer�the�questions�below.��(Remember:�Lake’s�made�a�profit�in�that�year����they�were�not�at�break�even�sales�last�year.)�

1. What�are�break�even�sales�for�Lake’s�Pharmacy?

2. What�additional�annual�sales�are�needed�if�rent�increases�by�$2,000/month?

©2015 BRS 13

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Break"even�Case�Study�"�Dollars�Lake’s�Pharmacy�

�. ��������� � ��������� �������������������� �������������������� �� ��!��"��������������� ���������������� ##������%����������&���������*

-. "���������������������� ���������� ������<���������&������������ ��������������� ��� ���*

©2015 BRS 14

Page 16: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Break"even�Case�Study�"�Units�Lake’s�Pharmacy�

Lake’s�has�a�homogeneous�unit����prescriptions����that�can�be�used�to�measure�all�product�sold.��What�René�and�Brad�need�to�know�now�are�how�many�prescriptions�they�need�to�sell.��Here�is�the�cost�breakdown�per�prescription:�

Sales�Price�(per�prescriptions)�..........�$56.80/�prescriptions�

Variable�Cost�(per�prescriptions)�......�$43.50/�prescriptions�

Fixed�Cost��...................................................�$490,800�

1. How�many�prescriptions�must�be�sold�to�break�even?

2. How�many�prescriptions�must�be�sold�by�a�new�Pharmacist�(who�will�get�an�annualsalary�of�$95,000)�to�cover�their�cost?

3. How�many�prescriptions�must�be�sold�if�the�selling�price�is�raised�to�$57.63�perprescription����assuming�there�is�no�new�salesperson�and�no�change�in�variablecost?

What�if�price�decreases�to�$55.37?�

©2015 BRS 15

Page 17: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Expansion�Case�Lake’s�Pharmacy�

The�Profit�Mastery®�process�and�tools�combined�with�René�and�Brad‘s�marketing�skills�have�them�contemplating�another�store.��This�store�will�be�located�in�an�area�similar�to�the�current�location,�and�where�they�have�noticed�that�the�competition�is�weak.��So�they�pulled�together�the�following�information�to�help�him�make�the�decision:���

�� Expected�Variable�Cost�Percentage..................76%��� Expected�Fixed�Costs.....................................$350,000��� Investment�in�Current�and�Fixed�Assets...........$400,000��� Minimum�return�on�investment.......................20%��

�1. What�total�sales�are�necessary�to�cover�their�fixed�costs�and�minimum�ROI?�(Follow�

these�steps)��� a.�Investment�x�minimum�ROI�=�profit�required�to�achieve�ROI����� b.�Fixed�costs�+�ROI�=�Total�cost�to�be�covered����� c.�100%���variable�cost�%�=�Contribution�Margin������ d.�Total�Cost/�CM%�=�Sales�Target����

2. How�many�customers�must�Lake’s�attract�to�the�new�store�to�break�even?�(Use�your�store’s�average�dollars�purchased�per�customer).�

©2015 BRS 16

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Break"Even�Analysis�Break�even�analysis�identifies�that�point�where�revenues�exactly�cover�costs����so�that�no�profit�is�generated,�but�no�loss�is�incurred.��As�a�management�tool,�it�extends�to�a�much�broader�application.��Using�it,�you�can�answer�questions�such�as:

�WhatadditionalsaleswillIneedtocovertherentincreasemylandlordisproposing?

�IfIraiseprices,howmuchcanmysalesdropbeforemyprofitsareaffected?

�Ifsalesdrop(inarecession,forexample),howmuchdoIneedtocutfixedcoststomaintainmycurrentlevelofprofit?

�IfIcutmyprice,whatadditionalsaleswillIhavetomakeinordertomaintainmycurrentprofitlevel?

Steps�to�Calculate�Break"Even�

Step�1�

Classify�expenses�from�your�current�income�statement�into�two�cost�categories:��fixed�or�variable.��Then�add�up�the�total�for�each�category.�

Fixed�Costs����are�those�that�remain�constant�over�a�reasonable�range�of�sales,�or�do�not�vary�appreciably�with�sales�volume.��For�example:�

� Rent � Office�Supplies � Advertising

� Salaries � Payroll�Taxes � Utilities

� Depreciation � Interest�Expense � Insurance

When�these�do�change,�they�tend�to�jump�in�increments����such�as�rent�increases�for�additional�space,�depreciation�on�new�equipment�purchases,�or�salaries�for�additional�staff.��When�this�type�of�increase�occurs,�break�even�needs�to�be�recalculated.�

Variable�Costs����are�those�that�vary�directly����or�proportionally����to�sales.��An�easy�way�to�evaluate�whether�a�cost�is�fixed�or�variable�is�to�ask:��do�sales�cause�this�cost?��If�sales�cause�the�cost,�it's�variable.��For�example:�

� Direct�Labor � Commissions

� Direct�Materials � Bad�Debts

If�you�can't�decide�what�to�call�an�expense,�be�conservative�and�call�it�fixed����thus�making�your�break�even�point�higher.�

©2015 BRS 17

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Step�2�Determine�the�variable�expense�percentage����that�is,�the�total�variable�expense�as�a�percentage�of�sales:�

VARIABLE��COSTS��=��VARIABLE��COST��PERCENTAGE�SALES�

Step�3�Determine�the�contribution�margin����that�is,�the�amount�from�each�sales�dollar�which�is�left�after�deducting�variable�costs����to�cover�fixed�costs:�

SALES�%��–��VARIABLE�COST�%��=��CONTRIBUTION�MARGIN�%�

Which�is�the�same�thing�as:�

100%��–��VARIABLE�COST�%��=��CONTRIBUTION�MARGIN�%�

Step�4�Calculate�break�even�using�one�of�the�two�following�formulas:�

To�calculate�break�even�in�dollars:�

BREAK–EVEN��=�������������FIXED�COSTS�������CONTRIBUTION�MARGIN%�

NOTE:��Express�contribution�margin�as�a�decimal�""�not�a�percentage.�

To�calculate�break�even�in�units�(ifyourproductcanbemeasuredinjustonetypeofunitsuchasyards,gallons,cases,orhours):�

BREAK–EVEN��=��������������FIXED�COSTS��SELLING� VARIABLE�

PRICE� –COSTPER�UNIT� PER�UNIT�

©2015 BRS 18

Page 20: Break-Even ˘ ˇˆ ˙ ˝ ˝˙ˆ · Profit Mastery Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119 Phone 206-284-5102 info@profitmastery.net

Cost�–�Volume�–�Profit�Relationships�Break�Even�Analysis:�Dollar�Basis�

Step�1�""�Classify�Your�Costs�

Using�your�most�recent�income�statements,�classify�all�costs�as�either�fixed�or�variable,�then�total�each�category.�Actual�Total�Sales� =��$_______________�

Total�Variable�Costs� =��$_______________�

Total�Fixed�Costs� =��$_______________�

Step�2�""�Calculate�Variable�Cost�Percent�

“Forevery$1.00ofsales,whatpercentgoesawaytovariablecosts.”�

Variable�Cost�Percentage��=��Total�Variable�Costs���=� $_______________��=��_____%�Actual�Total�Sales� $�

Step�3�""�Calculate�Contribution�Margin�

“Forevery$1.00ofsales(afterpayingforvariablecosts),whatpercentislefttocoverfixedcosts...plusanytargetedprofit?”�

100%�–�Variable�Cost�Percentage��=��100%��–��_____%��=��_____%�

Step�4�""�Calculate�Break"Even�Sales�

“Howmany‘centses’doesittaketocoveryourfixedcosts?”�

Break�Even�Sales��=���Total�Fixed�Costs����=��$_______________��=��$_______________��Contribution�Margin�%������������������������������%�

NOTE:��Tocalculatethesalesneededtogenerateatargetprofit,justaddthattargetprofitamounttoyour totalfixedcosts,thendividethatamountbyyourcontributionmargin.

Step�5�""�Check�Your�Calculations�

“Doesthesaleslevelyoufiguredactually‘breakeven’orgiveyoutheprofitsyoutarget?”�� � Break�Even�Sales� � _______________�

minus� Variable�Costs�*� – _______________

equals� Contribution�Dollars� =� _______________�

minus� Fixed�Costs� – _______________

equals� Net�Profit� =� _______________�

* ComputethisfigurebymultiplyingBreakEven(above)bytheVariableCostPercentinStep2.

©2015 BRS 19

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Cost�–�Volume�–�Profit�Relationships�Break�Even�Analysis:�Unit�Basis

Step�1�""�Classify�Your�Costs�

Using�your�most�recent�income�statements,�classify�all�costs�as�either�fixed�or�variable,�then�total�each�category.��Record�the�actual�number�of�units�sold�and�actual�sales�volume.�

Actual�Total�Sales� =��$_______________�

Total�Variable�Costs� =��$_______________�

Total�Fixed�Costs� =��$_______________�

Total�Units�Sold� =��________________�

Step�2�""�Calculate�Your�Price�Per�unit�

Price�Per�Unit��=�����������Total�Sales�����������=��$_______________�per�unit�Number�of�Units�Sold�

Step�3�""�Calculate�Your�Variable�Cost�Per�Unit�

Variable�Cost�Per�Unit��=��Total�Variable�Costs��=��$_______________�per�unit�Total�Units�Sold�

Step�4�""�Calculate�Your�Contribution�Dollars�Per�Unit�

Price�per�Unit��–��Variable�Cost�per�Unit�

=��$___________per�unit��–��$_________�per�unit��=��$_____________�per�unit�

Step�5�""�Calculate�Your�Break"Even�Sales�in�Units�

Break�Even�Sales��=����������Total�Fixed�Costs��������Contribution�Dollars�per�Unit�

=� $_______________� =� __________�units�needed�in�sales�to�“break�even”�$�������������������per�unit�

NOTE:� Tocalculatethesalesneededtogenerateatargetprofit,justaddthattargetprofitamounttoyourtotalfixedcosts,thendividethatamountbyyourcontributionmargin.

©2015 BRS 20