NEOCALC

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NeoCalc Comprehensive Break-Even Analysis

This workbook was produced at the request of hundreds of our loyal visitors to our great demand for an in-depth understanding of the financial "tool-of-tools" known Actually the Break-Even is only a portion of a larger concept known as "Contribution has at its heart the analysis of cost/volume/and profit relationships. This product makes an attempt at demystifying all of these concepts with examples This workbook can be used with your business by entering your own data. We suggest that you print the included Adobe Acrobat PDF file or MS Word unprotected so be careful with cells that contain formulas.
Copyright, 2010, JaxWorks, All Rights Reserved.
Even Analysis
to our web site. It appears there is a known as the Break-Even Analysis. "Contribution and Margin Analysis" that
examples and popup explanations.
Word Document. This workbook is
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JaxWorks Break-Even Analysis
Calculating The Contribution Margin - Figure 1 Sales (1000 CDs @ $10) Less: Costs associated with production: Employee costs (1000 CDs @ $0.50): Materials costs (1000 CDs @ $5): Packaging costs (1000 CDs @ $1): Total variable costs: Contribution margin: $500 $5,000 $1,000 $6,500 $3,500 $10,000
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Contribution Margin Analysis - Figure 2 CDs Sold: Sales @ $10 per CD Less: Variable costs of production: Employee costs (semi-variable): Materials costs (variable) Packaging costs (variable) Total variable costs: Contribution margin: $3,059.00 $22,550.00 MaterialsCost: $4,510.00 PackagingCost: $30,119.00 $14,981.00 $1.00 $5.00 4510 $45,100.00 Employee cost calculation CDsMade 0 1000 2000 3000 4000 5000
UnitCost $0.50 $0.60 $0.70 $0.80 $0.90 $1.00
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Per Unit and Percent of Sales Contribution Analysis - Figure 3 Employee cost per quantity $500.00 $600.00 $700.00 $800.00 $459.00 $0.00 CDs Sold 4510 Sales (CDs @ $10 each) Less: Labor (CDs at semi-variable per CD) Materials (CDs at $5 per CD) Packaging costs @ $1 per CD Contribution Margin $3,059.00 $22,550.00 $4,510.00 $14,981.00 Total $45,100.00
CDs Sold 5510 Sales (CDs @ $10 each) Less: Labor (CDs at semi-variable per CD) Materials (CDs at $5 per CD) Packaging costs @ $1 per CD Contribution Margin $4,010.00 $27,550.00 $5,510.00 $18,030.00 Total $55,100.00
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ution Analysis - Figure 3
Operating Income Statement - Figure 4 Total Per unit $2,000 $20 $400 $900 $300 $400 $4 $9 $3 $4
Per Unit % of Margin $10.00 100.00%
Sales Less: Materials Labor Variable Overhead Contribution margin:
$0.68 $5.00 $1.00 $3.32
6.78% 50.00% 10.00% 33.22%
Quantity Sold or Produced
100
Per Unit % of Margin $10.00 100.00%
$0.73 $5.00 $1.00 $3.27
7.28% 50.00% 10.00% 32.72%
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me Statement - Figure 4 Percent of margin 100% 20% 45% 15% 20%
Excel Formulas for Operating In
Sales Less: Material Labor Variable Overhead Contribution margin:
Quantity Sold or Produced
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Excel Formulas for Operating Income Statement - Figure 5 Total AN16*AO8 $AN$16*AO10 $AN$16*AO11 $AN$16*AO12 AN8-SUM(AN10:AN12) Per unit $20 Percent of margin 100%
$4 AO10/$AO$8 $9 AO11/$AO$8 $3 AO12/$AO$8 AO8-SUM(AO10:AO12) AO13/$AO$8
100
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Using Goal Seeker to Find Break-Even - Figure 6 Fixed costs Sales price Variable cost Break-Even units 50 20 15 10
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Fixed Costs - Figure 7 Volume (units) 1 2 3 4 5 6 7 8 9 10 Fixed Costs $50 $50 $50 $50 $50 $50 $50 $50 $50 $50
$60
$50
$40 Costs
$30
$20
$10
$0 1 2 3 4 5 6 7 8 9 Volume (units)
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Variable Costs Volume (units) 1 2 3 4 5 6 7 8 9 10 Variable Costs $15 $30 $45 $60 $75 $90 $105 $120 $135 $150
Fixed Costs
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Variable Costs - Figure 8
$160 $140 $120 $100 Costs $80

Variable Costs
$60 $40 $20 $0 1 2 3 4 5 6 7 8 9 10 Volume (units)
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The Classic Break-Even Point Chart - Figure 9 Volume Fixed Variable Total Total (units) Costs Costs Costs Sales 1 $50 $15 $65 $20 2 $50 $30 $80 $40 3 $50 $45 $95 $60 4 $50 $60 $110 $80 5 $50 $75 $125 $100 6 $50 $90 $140 $120 7 $50 $105 $155 $140 8 $50 $120 $170 $160 9 $50 $135 $185 $180 10 $50 $150 $200 $200 11 $50 $165 $215 $220 12 $50 $180 $230 $240 13 $50 $195 $245 $260 14 $50 $210 $260 $280 15 $50 $225 $275 $300 16 $50 $240 $290 $320 17 $50 $255 $305 $340 18 $50 $270 $320 $360 19 $50 $285 $335 $380
$400 $350 $300 $250
Costs
$200 $150 $100 $50 $0
Volume (units)
Fixed Costs Total Costs Total Sales
$4,000
The graphical representation of a company's current cost/volume/profit relationship gives you an effective tool for determining what adjustments you need to make to volume, cost, or both so as to increase your profit level. Relationships among these variables can become extremely complex, especially when several different products are involved. When you are dealing with a complicated situation, it is usually easier to make sense of the relationships by viewing them on a chart, rather than by gazing at a table of raw numbers.
$3,500 $3,000 $2,500
Break-Even Loss
Costs
$2,000 $1,500 $1,000 $500 $0
11
13
15
17
Volume (units) Fixed Costs T otal Costs T otal Sales
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19
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Non-linear Revenue Growth From Giving Discou Sales Price per Unit = Volume (units) 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 $20 Discount Revenue 0.0% $100 2.5% $195 5.0% $285 7.5% $370 10.0% $450 12.5% $525 15.0% $595 17.5% $660 20.0% $720 22.5% $775 25.0% $825 27.5% $870 30.0% $910 32.5% $945 35.0% $975 37.5% $1,000 40.0% $1,020 42.5% $1,035
$1,200
$1,000
$800 Revenue
$600
$400
$200
$0
Total Sales
Profit
11
13
15
17
me (units) T otal Sales
Costs
19
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owth From Giving Discounts - Figure 10 Sales Price per Unit = Volume (units)
Non-linear Increas
$1,200
$1,000
$800
$600
$400
$200
$0
Volume (units)
5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90
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Non-linear Increases In The Contribution Margin From Purchase Discounts - Figure 11 $20 Supplier Variable Sales Contribution Discount Costs margin 0.0% $75 $100 $25 2.5% $146 $200 $54 5.0% $214 $300 $86 7.5% $278 $400 $123 10.0% $338 $500 $163 12.5% $394 $600 $206 15.0% $446 $700 $254 17.5% $495 $800 $305 20.0% $540 $900 $360 22.5% $581 $1,000 $419 25.0% $619 $1,100 $481 27.5% $653 $1,200 $548 30.0% $683 $1,300 $618 32.5% $709 $1,400 $691 35.0% $731 $1,500 $769 37.5% $750 $1,600 $850 40.0% $765 $1,700 $935 42.5% $776 $1,800 $1,024
$1,200
$1,000
Contribution Margin
$800
$600
$400
$200
$0
Volume (units)
Contribution margin
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Sales Mix Analysis - Figure 12 Fixed costs = $34,000 8-oz. Package size Sales (units) Sales (dollars) Less variable costs (as % of Sales) Contribution margin (as % of Sales) Sales mix Break-Even 10,000 $74,000 $37,500 51% $36,500 49% 27% $68,932 Per Unit $7.40 $3.75 6-oz. 15,000 $94,050 $50,850 54% $43,200 46% 35% $74,021 Per Unit $6.27 $3.39 4-oz. 20,000 $102,600 $60,600 59% $42,000 41% 38% $83,057
$3.65
$2.88
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Redistribution of Sales Mix To Increase Profits - Fi Fixed costs = Per Unit $5.13 $3.03 $34,000 8-oz. Total $270,650 $148,950 55% $121,700 45% 100% $75,613 Package size Sales (units) Sales (dollars) Less variable costs (as % of Sales) Contribution margin (as % of Sales) Sales mix Break-Even 15,000 $111,000 $56,250 51% $54,750 49% 42% $68,932 Per Unit $7.40 $3.75 6-oz. 20,000 $125,400 $67,800 54% $57,600 46% 48% $74,021
$2.10
$3.65
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Mix To Increase Profits - Figure 13
Analyzing Segment Margin
Per Unit $6.27 $3.39
4-oz. 5,000 $25,650 $15,150 59% $10,500 41% 10% $83,057
Per Unit $5.13 $3.03
Total $262,050 $139,200 53% $122,850 47% 100% $72,525
Sales Less variable costs Contribution margin Less direct fixed costs
$2.88
$2.10
Segment margin
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Analyzing Segment Margin - Figure 14 Household Ceramics $1,100 $690 $410 $200 $210 Ceramic Tiles $3,500 $2,000 $1,500 $1,000 $500 Ceramic Conductors $5,000 $3,750 $1,250 $1,000 $250
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JaxWorks Break-Even Analysis Chart Presentation

$400 $350 $300 $250 Costs $200 $150 $100 $50 $0
Volume (units)
Fixed Costs Total Costs Total Sales
Copyright, 2010, Jaxworks, All Rights Reserved.
BREAK-EVEN ANALYSIS
Enter figures in cells with Blue numbers and White Background only. This worksheet is designed to perform what-if analysis in the projected cells. After entering your current data, you can experiment by reducing Variable and/or Fixed Expenses or increasing Sales. You will find it is much easier to reduce expenses than increase Sales. Scroll Down for Pie Charts.
Current
Sales $ $ Fixed $ $ Total Variable $ Total Variable % Profit $ Break-Even % BE Dollars $ BE Date 967,818 170,124 $806,197 83.30% ($8,503) 105.26% 1,018,736 Jan 18 $ $ $
Projected
967,818 170,124 $706,197 72.97% $91,497 65.03% 629,342 Aug 24
Current BE Chart
Sales $ $ Fixed $ $ Total Variable $ 967,818 170,124 $806,197
Projected BE Chart
Sales $ $ Fixed $ $ Total Variable $ 967,818 170,124 $706,197
Current Break-Even Chart Analysis
Projected Break-Even Chart Analysis
$1,200,000
$1,200,000
$1,000,000
$1,000,000
THE B/E POINT IS IN NEXT YEAR BECAUSE PROFIT IS NEGATIVE.
$800,000
$800,000
$600,000
$600,000
$400,000
$400,000
$200,000
$200,000
$0 Jan
May
Nov
Jul
Sep
Mar
$0
Jan
May
Months
Months
Click Here For Large View
Current Pie
Fixed % Total Variable % Profit % 17.58% 83.30% (0.88%)
Projected Pie
Fixed % Total Variable % Profit % 17.58% 72.97% 9.45%
Fixed %
Total Variable %
Profit %
Fixed %
Total Variable %
Profit %
Nov
Jul
Sep
Mar
Current Break-Even Chart Analysis

$1,200,000 $1,000,000
$800,000
$600,000 $400,000
$200,000 $0 May Aug Nov Dec Sep

Mar Jan
Jul
Jun
Feb
Apr
Months
Return To Data Entry
Oct
Break-Even Chart Analysis

$1,200,000
$1,000,000
$800,000 $600,000
$400,000
$200,000 $0 May Aug

Nov Dec
Sep
Mar
Jan
Jul
Feb
Apr
Jun
Months
Return To Data Entry
Oct
Break-Even Chart Analysis

$2,500,000
Profit
Total Costs
$2,000,000 $1,500,000 $1,000,000
Revenue
Loss
Fixed Costs
$500,000
Break-Even Point
$0
Oct
Aug
Nov
Apr
Jun
Jul
May
Months
Sep
Dec
Mar
Feb
Jan
Retur
(0.88%) 17.58%
83.30%
Fixed %
Total Variable %
Profit %
Current Pie
Retur
9.45% 17.58%
72.97%
Fixed %
Total Variable %
Profit %
Projected Pie
Planning For Profit

Applying Break-Even Tools
The concepts of operating leverage and financial leverage are key to an accurate analysis of a companys value. A firm is leveraged whenever it incurs either fixed operating costs (operating leverage) or fixed capital costs (financial leverage). More specifically, a firms degree of operating leverage is the extent to which its operations involve fixed operating expenses such as fixed manufacturing costs, fixed selling costs, and fixed administrative costs.
A firms degree of financial leverage is the extent to which that firm finances its assets by borrowing. More specifically, financial leverage is the extent to which a firms Return on Assets exceeds the cost of financing those assets by means of debt. The firm expects that the leverage acquired by borrowing will bring it earnings that will exceed the fixed costs of the assets and of the sources of funds. The firm expects that these added earnings will increase the amount of returns to shareholders. Today it is almost impossible for a firm to succeed financially without using some form of leverage. Firms commonly use leverage as a tool to help bolster their financial position and operating condition (for example, their return to stockholders). However, with increased leverage comes increased risk. If your company chooses to be highly leveraged, it must be willing to accept the risk that the downside losses will be as great as its upside profits. This can easily occur if a firms sales volume is not large enough to cover its fixed operating expenses and the required interest payments on its debt.
You can find plenty of examples of this phenomenon in a stack of annual reports from the 1980s. Within that stack you can find several companies that were highly leveraged. Tracking these firms through the 1990s, you would see trends depicting peaks and troughs: the positive and the negative impacts of using leverage to operate a business. Many firms were acquired via "Leveraged buyouts," where the funds needed to make the acquisition were themselves borrowed (hence the term "leveraged").
The likelihood of experiencing these kinds of swings is one reason that managers, analysts, and stockholders must apply the concepts of operating and financial leverage to accurately analyze a firms overall value and financial health.
An additional concept that is useful in interpreting the risks due to operating leverage and financial leverage is business risk. Business risk is the inherent uncertainty of doing business. It represents the risk that a company assumes by the nature of the products it manufactures and sells, its position in the marketplace, its pricing structurein short, all the fundamental aspects involved in the creation of profitable revenues. Assuming a higher degree of operating or financial leverage is seldom risky when the business risk is very low. But if the business risk itself is high, then increasing the degree of either type of leverage compounds the risk.
Analyzing Operating Leverage Operating leverage is the extent to which a firms operations involve fixed operating expenses. Managers can define the degree of operating leverage they want the firm to incur, based on the choices they make regarding fixed expenses. They can, for example, acquire new equipment that increases automation and reduces variable labor expenses. Alternatively, they can choose to maintain their variable labor expenses. Other things being equal, the more automated equipment a firm acquires through capital investment, the higher its operating leverage will be.
Copyright, 2010, Jaxworks, All Rights Reserved. Page 49
Case Study: Greeting Cards You own a small company that prints customized greeting cards. At present, your variable operating costs are $0.03 per card to print a box of 500 cards, which you sell for $35.00. One of your employees suggests that, if you purchase a personal computer and a modem, your customers could send their own designs for greeting cards to you electronically. This would save you the cost of doing the design and layout of the cards for each order.
You review some recent orders and find that you paid an employee an average of $3.00 per order to do the design and layout. So your costs and profit per order are as follows: Variable $0.03 per card for 500 cards = $15.00 Fixed design and layout per box = $3.00 Total cost per box: $18.00 Operating income per box: $17.00 If you can remove the cost of design and layout, your total costs will drop from $18.00 to $15.00 per order and your operating income per box will increase from $17.00 to $20.00. On the other hand, purchasing a computer and a modem will cost $1,400. This will introduce a new, fixed cost to the production of the cards. You will have to sell 70 boxes of greeting cards (70 boxes * $20.00 profit) to cover the cost of the equipmentthat is, to break even on the investment.
You should base your decision on how dependable your business card orders are. Suppose that you have a steady stream of around 60 orders per month. In that case, you break even on the investment in a little over a month, and after that you show an additional $3.00 profit for every order. That added profit is the result of leveraging your capital investment. Now suppose that your business card orders are not so dependable. Most of your business depends on the patronage of one large account. When its business is good, and it is hiring and promoting staff, you receive frequent orders from it for greeting cards. But when its business is not so good, you can go for several months with only a few orders. If the timing of your investment in the computer coincides with a drop in orders for greeting cards, the computer could sit idle for several months. There will be little profit to cover its cost, the break-even point will be pushed well into the future, and you will have lost the opportunity to invest the $1,400 in some other manner, such as advertising. The leverage is actually working against you. Of course, there are other considerations you must take into account. You would want to consider how many of your customers have the inclination and equipment to send their own designs to you, whether they would demand a price break if they do so, maintenance on the computer, and so on. Business decisions are seldom clear-cut.
So, operating leverage cuts both ways. A good decision can increase your profitability dramatically, once you have broken even on the fixed cost. Bad timing can cut your profitability dramatically if it takes longer than anticipated to break even on the investment. Case Study: Comparing the Degree of Operating Leverage For a more detailed example, consider three different specialty stores whose operations are identical in all respects, except for the decisions they have made regarding their variable and fixed expenses: Store A has decided to incur the lowest fixed and highest variable costs of the three stores. It has little in the way of special equipment, and relies heavily on the experience and knowledge of its salespeople. At this store, sales commissions are relatively high. Store A
Fixed costs: Units Sold (000) 20 50 80 110 140 170 200 $20,000.00 Sales $40,000 $100,000 $160,000 $220,000 $280,000 $340,000 $400,000 Variable costs: Fixed costs $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
Store A
$1.50 Variable Costs $30,000 $75,000 $120,000 $165,000 $210,000 $255,000 $300,000
Unit price: Total Costs $50,000 $95,000 $140,000 $185,000 $230,000 $275,000 $320,000
$2.00 Profits ($10,000) $5,000 $20,000 $35,000 $50,000 $65,000 $80,000
$450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0

20 50 80 110 140 170 200
Cost, Sales and Profit
Units Sold (000)
Store B has decided to incur fixed costs that are higher than that of Store A, but to keep its variable costs lower than Store A. This store has invested a moderate amount of money in paint-mixing equipment that enables a salesperson to match paint samples automatically. It believes that reliance on this equipment allows it to hire salespeople who are less experienced; its sales staff therefore does not earn as much as that at Store A.
Store B
Store B $450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0
20 50 80 110 140 170 200
$1.20 Variable Costs $24,000 $60,000 $96,000 $132,000 $168,000 $204,000 $240,000
$2.00 Profits ($24,000) $0 $24,000 $48,000 $72,000 $96,000 $120,000
Units Sold (000)
Store C has decided to incur the highest fixed and lowest variable costs of the three. It has invested heavily in equipment that not only matches paint samples exactly, but mixes paints automatically to produce a gallon of matching paint. Its salespeople need no special knowledge, and receive lower commissions than the sales staffs at Store A and Store B. Store C
Store C $450,000 $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0
20 50 80 110 140 170 200
$1.00 Variable Costs $20,000 $50,000 $80,000 $110,000 $140,000 $170,000 $200,000
$2.00 Profits ($40,000) ($10,000) $20,000 $50,000 $80,000 $110,000 $140,000
Units Sold (000)
The examples above display an analysis of each stores sales and Earnings Before Interest and Taxes (EBIT) for a given quantity of sales at their existing fixed costs, variable costs, and unit sales rates.
The examples also make some trends evident. These trends are consequences of each stores decision as to the relationship between its variable costs and its fixed costs: Store A, which has the lowest fixed cost and the highest per unit cost, will break even faster than Store B and Store C. However, once the break-even point has been met and as the level of production increases, Store As EBIT will not be as great as either Store Bs or Store Cs. This is because Store A has the highest per unit sales cost. No matter how many gallons of paint it sells, it incurs the same, relatively high sales commission on each sale.
Store B, which has fixed costs that fall between Store A and Store B, breaks even slower than Store A but faster than Store C. Once it reaches its break-even point, it is more profitable than Store A because its unit sales cost is lower than Store A. However, after breaking even on its paint-matching equipment, Store B is less profitable, in terms of EBIT, than Store C as sales increase: it pays its sales staff a higher commission than does Store C.
Store C, which has the highest fixed costs and the lowest per unit sales cost, breaks even more slowly than the other two stores. But after the break-even point has been reached, Store Cs EBIT rises faster than either Store A or Store B because of its low sales commission rates.
Store A Fixed costs: Variable costs: Sales price: $20,000 $1.50 $2.00 Store A Units Sold (000) 20 50 80 110 140 170 200 Sales $40,000 $100,000 $160,000 $220,000 $280,000 $340,000 $400,000 Store B 20 50 80 110 140 170 200 $40,000 $100,000 $160,000 $220,000 $280,000 $340,000 $400,000 Store C 20 50 80 110 140 170 200
$160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 ($20,000) ($40,000) ($60,000) 20
Store B $40,000 $1.20 $2.00
Store C $60,000 $1.00 $2.00
Fixed costs $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
Variable Costs $30,000 $75,000 $120,000 $165,000 $210,000 $255,000 $300,000
Profits ($10,000) $5,000 $20,000 $35,000 $50,000 $65,000 $80,000
$40,000 $40,000 $40,000 $40,000 $40,000 $40,000 $40,000
$24,000 $60,000 $96,000 $132,000 $168,000 $204,000 $240,000
($24,000) $0 $24,000 $48,000 $72,000 $96,000 $120,000
$40,000 $100,000 $160,000 $220,000 $280,000 $340,000 $400,000
$60,000 $60,000 $60,000 $60,000 $60,000 $60,000 $60,000
$20,000 $50,000 $80,000 $110,000 $140,000 $170,000 $200,000
($40,000) ($10,000) $20,000 $50,000 $80,000 $110,000 $140,000
Profits ($)
50
80
110
140
170
200
Units Sold (000)

Store A Store B Store C
Store A
Store B
Store C
Degree of Operating Leverage (DOL) Another way to understand how operating leverage impacts your companys profitability is by calculating the Degree of Operating Leverage (DOL): DOL = Units*(Price-Variable Cost)/(Units*(Price-Variable Cost)-Fixed Cost) or, equivalently: DOL = Contribution Margin/(Contribution Margin Fixed Cost) Using the data for the three specialty stores, one can calculate the DOL at the point where unit sales are 120,000: Store A, for example, has a DOL of 1.5 with unit sales of 120,000: DOL =120,000*($2.00-$1.50)/(120,000*($2.00-$1.50)=$20,000) DOL = 1.5 These calculations quantify the data shown in example below. The numbers indicate that the EBIT of the companies that have the greatest operating leverage are also the most sensitive to changes in sales volume.
Store A Fixed costs: Variable costs: Sales price: Units Sold 000 Store A Store A Store B Store B Store C Store C
$160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0
120
Store A
Store B $40,000 $1.20 $2.00 Fixed costs $20,000 $20,000 $40,000 $40,000 $60,000 $60,000 $1.50 $2.00
Store C $60,000 $1.00 $2.00 Variable costs $180,000 $300,000 $144,000 $240,000 $120,000 $200,000 EBIT $40,000 $80,000 $56,000 $120,000 $60,000 $140,000 DOL 1.50 1.25 1.71 1.33 2.00 1.43
$20,000
Sales 120 200 120 200 120 200 $240,000 $400,000 $240,000 $400,000 $240,000 $400,000
Profit ($)
200
Store A
120
Store B
200
Store B
120
Store C
200
Store C
Units Sold (000)
Each store sells the same number of units: 120,000 or 200,000. Each store sells them for the same price: $2.00 per unit. But because the stores differ in their fixed and variable costs, they also differ in their 1 BIT. For Store A, a 67% increase in unit sales from 120,000 to 200,000 results in a (67% * 1.5 DOL) or 100% increase in EBIT. For Store B, a 67% increase in unit sales results in a (67% * 1.7 DOL) or 114% increase in EBIT. And Store C experiences a (67% * 2.0 DOL) or 133% increase in EBIT. So, the higher the DOL, the greater the EBIT as unit sales increase.
Expressed in raw dollar amounts, an increase in unit sales from 120,000 to 200,000 means an increase in profits of $40,000 for Store A, $64,000 for Store B, and $80,000 for Store C.
However, the calculated DOL will be the same on the downside. So for every decrease in sales volume, each firms DOL will cause an unwanted decrease in EBIT corresponding to the desired increase in EBIT (see example below).
Store A Fixed costs: Variable costs: Sales price: Units Sold (000) Store A Store A Store B Store B Store C Store C $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0
200 Store A 120 Store A 200 Store B
Store B $20,000 $1.50 $2.00 Sales $400,000 $240,000 $400,000 $240,000 $400,000 $240,000 $40,000 $1.20 $2.00 Fixed costs $20,000 $20,000 $40,000 $40,000 $60,000 $60,000
Store C $60,000 $1.00 $2.00 Variable costs $300,000 $180,000 $240,000 $144,000 $200,000 $120,000 EBIT $80,000 $40,000 $120,000 $56,000 $140,000 $60,000 DOL 1.25 1.50 1.33 1.71 1.43 2.00
200 120 200 120 200 120
Profit ($)
120 Store B
200 Store C
120 Store C
Units Sold (000)
The DOL gives managers a great deal of information for setting operating targets and planning profitability. For example, you would want to make operating leverage decisions based on your knowledge of how your sales volume fluctuates. If your company experiences large swings in sales volume throughout the year, it would be much riskier to maintain a high degree of leverage than it would be if your company has a predictable, steady stream of sales.
Case Study: Hot-dog Sales HotDog Man is a small business that sells specialty coffee drinks at office buildings. Each morning and afternoon, trucks arrive at offices front entrances, and the office employees purchase hotdogs and drinks. The business is profitable, but HotDog Mans offices are located to the north of town, where rents are less expensive, and the principal sales area is south of town. This means that the trucks must drive crosstown four times each day.
The cost of transportation to and from the sales area, plus the power demands of the trucks coffee brewing equipment, are significant portions of the variable costs. HotDog Man could reduce the amount of drivingand, therefore, the variable costsif it moves the offices much closer to the sales area.
HotDog Man presently has fixed costs of $10,000 per month. The lease of a new office, closer to the sales area, would cost an additional $2,200 per month. This would increase the fixed costs to $12,200 per month (see below).
Units sold per month Average unit sales price
20,000 Unit variable costs $2.20 Current fixed costs Contribution margin DOL
$0.60 $10,000 $202,986 2.45 Fixed Variable Costs $3,949 $6,673 $8,507 $8,215 $6,958 $5,759 $5,948 $6,556 $8,609 $7,779 $4,183 $2,983 Sum: Standard Deviation: EBIT $531 $7,794 $12,685 $11,907 $8,555 $5,358 $5,861 $7,482 $12,958 $10,744 $1,155 ($2,045) $82,986 $4,963
1994 sales month January February March April May June July August September October November December
Units 6,582 11,121 14,178 13,692 11,597 9,599 9,913 10,926 14,349 12,965 6,972 4,972
Sales $14,480 $24,466 $31,192 $30,122 $25,513 $21,118 $21,809 $24,037 $31,568 $28,523 $15,338 $10,938
costs $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
Although the lease of new offices would increase the fixed costs, a careful estimate of the potential savings in gasoline and vehicle maintenance indicates that HotDog Man could reduce the variable costs from $0.60 per unit to $0.35 per unit. Total sales are unlikely to increase as a result of the move, but the savings in variable costs could increase the annual profit from $82,986 to $88,302. This is a 6.4% growth in profit margin: not an insignificant amount (see below).
Units sold per month Average unit sales price Additional monthly lease payment, new offices: Projected fixed costs: 1994 sales month January February March April May June July August September October November December $12,200 Fixed Units 6,582 11,121 14,178 13,692 11,597 9,599 9,913 10,926 14,349 12,965 6,972 4,972 Sales $14,480 $24,466 $31,192 $30,122 $25,513 $21,118 $21,809 $24,037 $31,568 $28,523 $15,338 $10,938 costs $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 $12,200 Variable Costs $2,304 $3,892 $4,962 $4,792 $4,059 $3,360 $3,470 $3,824 $5,022 $4,538 $2,440 $1,740 Sum: Standard Deviation: EBIT ($23.30) $8,374 $14,029 $13,130 $9,254 $5,558 $6,139 $8,013 $14,346 $11,785 $698 ($3,002) $88,302 $5,738 20,000 Unit variable costs $2.20 Current fixed costs Contribution margin $2,200 DOL $0.35 $10,000 $234,702 2.66
But look at the change in the variability of the profit from month to month. From November through January, when it is much more difficult to lure office workers out into the cold to purchase coffee, HotDog Man barely breaks even. In fact, in December of 1994, the business lost money. The example above indicates that by moving some of the expenses from the category of variable costs to that of fixed costs, HotDog Man increases total annual earnings but the variability of the earnings from month to month also increases. Although the company earns more during the spring and fall by reducing the variable costs, it loses more during the winter months because it must continue to meet its higher fixed costs.
This increase in variability is reflected in the month-to-month standard deviation of earnings, which is shown in both examples directly under the annual sum of earnings. The current cost structure results in a standard deviation of $4,963, but the projected cost structure has a month-to-month standard deviation of $5,738. The increase in variability is also reflected in the HotDog Mans DOL. As shown in both examples, the DOL would increase from 2.45 to 2.66 as a result of increasing fixed costs and decreasing variable costs. Both the DOL and the business risk would increase if HotDog Man moved its offices. If HotDog Man has plenty of money in the bank to meet unexpected expenses, such as major repairs to its trucks or the trucks coffee brewers, then the acceptance of greater fixed costs may make good financial as well as operational sense. But if HotDog Mans owners frequently take profits out of the business, so that it has relatively little in the way of resources to cushion the impact of unexpected expenses, it might be unwise to add to its fixed costs. Where will the money come from to repair a truck that breaks down at the end of January? Managers can use the DOL to plan not only their operations, as was done in the HotDog Man case study, but also their net income and their pricing. It is useful to perform sensitivity analysis around sales volume levels, and around adjustments to both fixed and variable expenses. Variability in profit levels, whether measured as EBIT, operating income, or net income does not necessarily increase the level of business risk as the DOL increases. If the variability is predictableif the timing and size of the swings can be forecast with confidencethen a company can anticipate and allow for them in its budgets.
Planning by Using the DOL In January, for example, the managers of Firms A, B, and C might set out their annual operations and profit targets by means of the following assumptions: We want to increase our sales volume from 120,000 to 200,000. Our market research leads us to believe that to sell an additional 80,000 units we must lower our unit sales price from $2.00 to $1.70. Neither total fixed costs nor unit variable costs will change during this year.
Based on these assumptions, the change in net operating income for each firm would be as shown below.
Unit Sales Unit Price Total Sales Fixed Costs Unit variable costs Total variable costs Net operating income Increase in net income
Firm A
120,000 200,000
$2.00 $1.70
$240,000 $340,000
$20,000 $20,000
$1.50 $1.50
$180,000 $300,000
$40,000 $20,000 ($20,000)
Firm B
120,000 200,000
$2.00 $1.70
$240,000 $340,000
$40,000 $40,000
$1.20 $1.20
$144,000 $240,000
$56,000 $60,000 $4,000
Firm C
120,000 200,000
$2.00 $1.70
$240,000 $340,000
$60,000 $60,000
$1.00 $1.00
$120,000 $200,000
$60,000 $80,000 $20,000
As before, Firm C has a higher DOL than either Firms A or B. Although the managers of Firm C believe that this works to their advantage, they should also perform the same analysis on the downside. If, despite reducing their unit sales price, their total sales remain at 120,000 instead of increasing to 200,000, the reduction in unit price would reduce profits by $36,000 instead of increasing them by $20,000. It is for this reason that companies with a high degree of leverage must be confident that their sales volumes will not fall. Otherwise, they run a significant risk of missing their profit objectives. Performing an analysis of the impacts that leverage can have on a firms profitability is essential to a clear picture of the risk a company has decided to take on. However, the DOL is only one of the indicators that a manager, shareholder, or creditor uses to measure the value and risk to a firms financial health. Another important measure is a companys degree of financial leverage. Analyzing Financial Leverage Financial leverage is the extent to which a company finances the acquisition of its assets by means of debt: that is, a company that borrows money to acquire assets engages financial leverage. This type of leverage is a critical component in the measurement of the financial health and value of a company. It helps managers, analysts, stockholders, as well as long and short-term creditors distinguish between a firms level of business risk and the financial risk that the firm has assumed. In contrast, financial risk is the additional exposure, above and beyond business risk, that a firm incurs by using financial leverage: that is, the debt that the firm assumes by financing the acquisition of its assets. Suppose, for example, that you decide to start a business that offers training classes in the design of business software. Your business risk consists of factors such as the desirability of the training, the number of people who might want it, the number of other firms that offer similar training classes, the market share of business software systems that you choose to focus on, and the quality and price of your service relative to that of your competition.
If you obtain a loan to finance the purchase of computer workstations for your clients to use during training, you have assumed an additional financial risk, beyond your business risk: the possibility that your firm will be unable to repay that loan from its earnings. It is useful to separate business from financial risk to make decisions pertaining to financial leverage. One way to focus on financial risk is to analyze a firms financial structure: that is, the way that the firm has gone about financing its assets. Part of a companys overall financial structure is its capital structure. The companys capital structure is the combination of various forms of debt and equity that are used to finance its assets.
A thorough understanding of the debt that your company has assumed significantly enhances your ability to make good decisions about acquiring new debt. As a creditor, it is essential to understand a borrowers capital structure in order to measure the risk of making a loan, and to determine whether the interest rate is in line with that risk.
The acquisition of additional debt, of course, changes a companys degree of financial leverage, and therefore new debt can have either a beneficial or a detrimental impact on the evaluations made by creditors and stockholders.
Suppose that you can obtain a loan at 9 percent interest to finance the acquisition of new computer workstations. If the return on the assets represented by the new workstations is 12 percent, you will have leveraged the loan, to your benefit. But if the return on this equipment turns out to be only 6 percent, the leverage works against you: you will pay more in interest than you will earn from the asset. Clearly, financial leverage is an important indicator to investors (should I buy this stock?), to managers (will this decision get me a promotion or a pink slip?), to stockholders (should I sell or stand pat?) and to creditors (can they repay this loan?). There are several financial leverage ratios that help you analyze a companys capital structure. These ratios include the Debt Ratio and the Times Interest Earned ratio. The ratios provide managers, analysts, investors, and creditors with useful indications of how financial leverage impacts the level of financial risk a company has assumed. The ratio information is critical for determining the stability, and even the solvency, of a company. Determining the Debt Ratio The Debt Ratio is the ratio of total debt to total assets. (Another term for the Debt Ratio is the Leverage Factor.) The example below calculates the Debt Ratio of three firms that are identical in all respects except for the amount of debt that they have assumed.
Total Debt Firm A Firm B Firm C $0 $2,000 $5,000 Total Assets $10,000 $10,000 $10,000 Debt Ratio 0% 20% 50%
The Debt Ratio measures the proportion of a firms total assets that are financed, both short-term and long-term, by means of creditors funds. Managers, analysts, shareholders, and creditors use the Debt Ratio as one indicator of how much risk a firm is carrying. For example, a companys value is in large measure a function of the value of its assets. If a firm has a high debt ratio, then a high proportion of its assets has been financed by means of debt. This implies that the company must spend a greater proportion of its earnings to pay off those debts, instead of reinvesting its earnings in the company.
On the other hand, a company with a low debt ratio has used its equity to acquire assets. This implies that it requires a smaller proportion of its earnings to retire debt, and the company can make more dollars available for reinvestment and dividends.
A firms debt ratio is also a useful indicator of how well it will weather difficult financial times. For example, if a company with a high debt ratio suffers significant earnings losses, it will be hard pressed to continue operations and simultaneously pay off its debts. But a company with a low debt ratio is in a much better position to continue operations if earnings decrease, because it will not need to use its earnings for debt retirement.
In debt ratio example, Firm C has the highest debt ratio. This implies that if the firm were to experience a recessionary period, the cash flow it generates may not be sufficient to meet principal and interest payments on the debt acquired. In this example, the Debt Ratio indicates that Firm C is at the greatest financial risk.
The Equity Ratio is the opposite of the Debt Ratio. It returns the ratio of a firms equity to its assets. The higher the Equity Ratio, the lower a firms financial leverage. Determining the Times Interest Earned Ratio Times Interest Earned refers to the number of times that interest payments are covered by a firms earnings. It is calculated by dividing the EBIT by interest charges: that is, the income that is available for the payment of interest, divided by the interest expense. Thus, the Times Interest Earned ratio indicates the extent to which a firms current earnings are able to meet current interest payments out of net operating income or EBIT. The example below shows possible Times Interest Earned ratios for three firms.
EBIT Firm A Firm B Firm C $200,000 $200,000 $200,000 Interest $30,000 $50,000 $100,000 Times Interest Earned 6.7 4.0 2.0
The Times Interest Earned ratios in the example indicate that Firm A, because it has relatively low debt, uses a lower proportion of its earnings to cover interest payments. Firm B covers annual interest payments four times at its current earnings level, and Firm C covers annual interest payments two times at its current earnings level.
Firm C runs a greater risk of financial difficulty than the other two firms. This is because it must cover interest payments before applying earnings to any other purpose, such as reinvestment. Summary In the business environment of the new millennium, operating and financial leverage are important ingredients in determining the success or demise of many companies. Firms acquire leverage to bolster their financial positions, thus increasing shareholder value. However, with increased leverage comes increased risk. Managers, analysts, shareholders, and creditors must be very clear about the implications of the risks associated with a firms operating and financial leverage to make investment decisions. Knowing these implications brings their decisions in line with their desired levels of risk.
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NeoCalc Comprehensive Break-Even Analysis

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examples and popup explanations.

Word Document. This workbook is

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

UnitCost $0.50 $0.60 $0.70 $0.80 $0.90 $1.00

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

ution Analysis - Figure 3

Per Unit % of Margin $10.00 100.00%

Sales Less: Materials Labor Variable Overhead Contribution margin:

$0.68 $5.00 $1.00 $3.32

6.78% 50.00% 10.00% 33.22%

Quantity Sold or Produced

Per Unit % of Margin $10.00 100.00%

$0.73 $5.00 $1.00 $3.27

7.28% 50.00% 10.00% 32.72%

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

me Statement - Figure 4 Percent of margin 100% 20% 45% 15% 20%

Excel Formulas for Operating In

Sales Less: Material Labor Variable Overhead Contribution margin:

Quantity Sold or Produced

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

$4 AO10/$AO$8 $9 AO11/$AO$8 $3 AO12/$AO$8 AO8-SUM(AO10:AO12) AO13/$AO$8

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

Variable Costs - Figure 8

$160 $140 $120 $100 Costs $80

$60 $40 $20 $0 1 2 3 4 5 6 7 8 9 10 Volume (units)

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

$400 $350 $300 $250

$200 $150 $100 $50 $0

$3,500 $3,000 $2,500

$2,000 $1,500 $1,000 $500 $0

Volume (units) Fixed Costs T otal Costs T otal Sales

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

me (units) T otal Sales

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis

JaxWorks Break-Even Analysis