Break-Even and Cost-VolumeProfit Analysis

Chapter 8

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

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

Determining the Break-Even Point

Break-even analysis may be based on

Historical data Future sales and costs

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

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

Income Statement

Sales Less variable expenses Total contribution margin Less fixed expenses Profit

xxx xxx xxx xxx xxx

Determining the Break-Even Point

Break-even = sales volume ($) Fixed costs Contribution margin ratio

Break-even = sales volume ($)

Fixed costs 1 (Variable costs/Sales)

Determining the Break-Even Point

Break-even sales in units = Fixed costs Contribution margin/unit

Break-even sales in units

Break-even sales in dollars Unit sales price

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

Equation Approach

Profit=
Sales revenue-variable expenses-fixed expenses

Profit=

(Unit sales price)*(sales volume)- (unit variable expenses)*(sales volume)-(Fixed expenses)

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

Break even Chart

Break even Chart

Changes in Fixed expenses

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

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.

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.

Profit-Volume Analysis

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

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

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