pp break-even analysis

7/28/2019 PP Break-Even Analysis

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Break-Even

Analysis

Prof. Dr. Dan Dumitru Popescu


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Main issues

1. Preparing Break-Even Analysis2.Shifts in the Break-Even Point

3. Methods for calculating the Break-Even

Point4. Volume changes and Net Income

5. Target Net Profit Analysis

6. Margin of Safety7. Operating Leverage

8. Multi-level Break-Even Analysis


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1. Preparing Break-Even Analysis

The three main elements of a budget are as follows:

Sales revenues Costs

Fixed costs

Variable costs

Semi-Variable costs

Profits

Assumptions when preparing a break-even analysis:

Selling prices do not change

Total fixed expenses remain the same

Variable expenses increase and decrease in direct proportion to sales

The basic Break-Even Formula is:


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Calculating the break-even point for a retail business:

S sales in monetary units at break-even point

FC fixed costs or operating expenses

VC variable costs or cost of goods

A more practical break-even formula can be derived as follows:

VCFCS

GP-SVCorVC-SGP(1) SGMGPor

S

GPGM(2)

VCFCS(3) S)](GM-SFCS [

GM

FCeven)-(breakBE

GMFCSorSGMFC


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Calculating the break-even point using the Markup Percentage:

Calculating the Break-even Point to a Service Provider:

BE volume of sales to break-even

Fixed costs fixed expenses, depreciation etc.

Variable costs cost of sales and variable expenses

Calculating the Break-even Point for a Manufacturer:

percentageMarkup

ExpensesOperatingBE

Sales

CostsVariable-1

CostsFixedBE

Cost/UnitVariable-PriceSelling

CostsFixedBE


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ASSUMPTIONS:All of the output is sold

All of the output is sold at the same price

Variable costs are constant (no economies of scale)

All information is not out of date


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2. Shifts in the Break-Even Point

2.1. Internal Factors

- exp: increase in total costs

(due to more staff)

- exp: increase in total

revenues (due to a price

increase)


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2. Shifts in the Break-Even Point

2.2. External Factors

- exp: recession, the product

would fall

- exp: inflation would push

up the variable cost


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3. Methods for calculating the Break-Even Point

Contribution margin is the amount through which sales (net of

variable expenses) contribute toward covering fixed expenses andthen toward profits.

3.1. Equation Method

Sales = Variable expenses + Fixed expenses + Profits3.2. Equation Method

The contribution margin ratio (CM) is the ratio of contribution margin

to total sales expressed as a percentage.

priceunitPermarginoncontributiUnitratioCM


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4. Volume changes and Net Income

Note the following points:

The contribution margin must first cover the fixed

expenses. If the contribution margin is not sufficient to

cover the fixed expenses, then a loss occurs for theperiod.

As additional units are sold, the fixed expenses are

whittled down little by little until they have all been

covered.

Once the break-even point is reached, net income

increases by amount of the unit contribution margin for

each additional unit sold.


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5. Target Net Profit Analysis

The formulas used to compute the break-even point can

also be used to determine the sales volume needed to

meet a target net profit figure.

Equation MethodN = Number of units to attain the targeted net profit

Y= Sales in m.u. to reach the targeted net profit figure

Sales = Variable expenses + Fixed expenses + Profits Price/unit x N = Variable exp./unit x N + Fixed exp. + Targeted Profit

Y = Variable exp. as a % of Selling price + Fixed exp. + Targeted Profit

Contribution Method


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6. Margin of Safety

The margin of safety (MS) is the excess of budgeted (or actual)

sales over the break-even sales. It shows the amount by whichsales can drop before losses begin to be incurred.

Operating leverage is a measure of the mix of variable and fixed

costs in a firm. The degree of operating leverage is not constant

itchanges with the level of sales.

7. Operating Leverage


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8. Comparison between Capital-Intensive and

Labor-Intensive Companies

Element

Capital-intensive

(automated)

company

Labor-intensive

company

The CM ratio for a given product will tend to be relatively High Low

Operating leverage will tend to be High Low

In periods of increasing sales, net income will tend to increase

Rapidly Slowly

In periods of decreasing sale, net income will tend to decrease

Rapidly Slowly

The volatility of net income with changes in sales will tend to be

Greater Less

The break-even point will tend to be Higher Lower

The MS at a given level of sales will tend to be Lower Higher

The latitude available to management in times of economic

stress will tend to be Less Greater

The overall degree of risk associated with operating activities

will tend to be Greater Less


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9. Multi-Product Break-Even analysis

When there are multiple products, break-even analysis can be

easily accomplished using the overall contribution margin ratio

Ways to Lower Break-Even:

1. Lower direct costs, which will raise the gross margin

2. Exercise cost controls on the fixed expense, and lowerthe necessary total monetary units

3. Raise prices!

pp break-even analysis

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