Break-Even and Cost-Volume-Profit Analysis

1. Break-Even and Cost-Volume-Profit Analysis Chapter 24

2. Break-even Analysis • Determines at what level cost and revenue are in equilibrium • Break-even point • Obtained directly by mathematical calculations • Usually presented in graphic form known as break-even chart

3. Determining the Break-Even Point • Each expense must be analyzed to determine its fixed and variable portions • Semi-variable expenses must be separated into their fixed and variable components • Fixed portion is stated as a total figure • Variable portion is stated as a rate or percentage

4. Determining the Break-Even Point • Break-even analysis may be based on • Historical data • Future sales and costs

5. Determining the Break-Even Point • Contribution margin ratio (C/M ratio) • Also known as marginal income ratio or Profit-volume ratio • Contribution of each dollar towards covering fixed costs and making a profit Contribution margin ratio = 1 – (Variable costs/Sales) OR Contribution margin ratio = unit contribution margin/unit sales price Contribution margin= sales – variable costs

6. Example • The ABC Lodge has sales of $4500,000. The fixed expense was $1,200,000 and the variable expense totaled $1,800,000. • Contribution margin ratio • Contribution margin

7. Income Statement • Sales xxx • Less variable expenses xxx • Total contribution margin xxx • Less fixed expenses xxx • Profit xxx

8. Determining the Break-Even Point Break-even = Fixed costs sales volume ($) Contribution margin ratio Break-even = Fixed costs sales volume ($) 1 – (Variable costs/Sales)

9. Determining the Break-Even Point Break-even = Fixed costs sales in units Contribution margin/unit Break-even = Break-even sales in dollars sales in units Unit sales price

10. Example • The ABC Lodge has sales of $4500,000. The fixed expense was $1,200,000 and the variable expense totaled $1,800,000. • Break even point in dollars

11. Equation Approach • Profit= Sales revenue-variable expenses-fixed expenses • Profit= • (Unit sales price)*(sales volume)- (unit variable expenses)*(sales volume)-(Fixed expenses)

12. Determining the Break-Even Point Break-even capacity %age = Break-even sales in dollars Normal sales volume in dollars Margin of Safety ratio = Sales – Break-even sales Sales Profit % = CM ratio x Margin of safety ratio

13. Break even Chart

14. Break even Chart • Changes in Fixed expenses • Original estimate new estimate • Fixed utilities expenses $1,400 $2,600 • Total Fixed expenses 48,000 49,200 • Breakeven calculation 48,00049,200 • (FC/unit contribution margin) $6 $6 • Break even point(units) 8,000units 8,200 units • Break even point (dollars) $128,000 $131,200

15. Break even Chart • Change in unit variable expenses • Increase in unit variable expenses will cause a decrease in unit contribution margin. • Break even will now be achieved at a higher output level.

16. Break even Chart • Change in sales price • Increase in sales price will cause an increase in unit contribution margin. • Break even will now be achieved at a lower output level. • However, careful analysis by the management is required as the increase in sales price might also cause a decline in output sold.

17. Profit-Volume Analysis

18. Target Net Profit • We can use break-even analysis to find the sales required to reach a target level of profit. • Number of sales units required to earn target profit: • = Fixed expenses+ Target net profit Unit contribution margin

19. Example • Calculate the number of units the company needs to sell in order to realize a Profit of $500,000? • Given: • Fixed costs= $100,000 • Sale price= $10 • Variable cost per unit= $5

20. Constructing a Break-even Chart • Example: • Fixed costs = $1,600,000 • Sales = $5,000,000 • Sales/unit = $4 • Variable cost/unit = $2.4/unit • Construct Break-even chart