TiE Young Entrepreneurs (TYE) A TiE-Boston Chapter Initiative MARKETING PART II | 31 January 2009 SESSION 3: What is an Break-even Analysis

Recap of what you have learnt… What is Marketing (4 P’s) Why do Marketing (Purpose) How to do effective Marketing Need to develop Vision to drive business Analyze consumers by segment Focus your brand Understand key concepts/elements to be effective Market Research Competitive strategies/advantages Advertising & Publicity Break-even analysis Can you afford your marketing plan & How to calculate it

What is Marketing (4 P’s)

Why do Marketing (Purpose)

How to do effective Marketing

Need to develop Vision to drive business

Analyze consumers by segment

Focus your brand

Understand key concepts/elements to be effective

Market Research

Competitive strategies/advantages

Advertising & Publicity

Break-even analysis

Can you afford your marketing plan &

How to calculate it

What is Break-even Analysis? Key element of marketing plan Answers: Can you afford your Marketing Plan? Sell enough units to cover its cost! Marketing is a fixed cost It is not affected by the number of units sold Break-even unit formula = Fixed operating cost / Gross profit per unit

Key element of marketing plan

Answers: Can you afford your Marketing Plan?

Sell enough units to cover its cost!

Marketing is a fixed cost

It is not affected by the number of units sold

Break-even unit formula =

Fixed operating cost / Gross profit per unit

Why Break-even Analysis Businesses do this analysis to help them arrive at a price allow them to make some profit know when that will happen in the future It is done for all businesses – little or big Main reason is to have some idea of how much to sell before you can start making a profit If the number you are trying to get is too difficult then maybe you can change it increasing your price or cutting your cost … that is the key to the analysis Understand this, makes you more competitive in the market place

Businesses do this analysis to help them

arrive at a price

allow them to make some profit

know when that will happen in the future

It is done for all businesses – little or big

Main reason is to have some idea of

how much to sell before you can start making a profit

If the number you are trying to get is too difficult

then maybe you can change it

increasing your price or cutting your cost

… that is the key to the analysis

Example: Basic Calculations Sum Calculation Price Item Description $26 - $6 $50 - $24 $100 - 50 $50 + $0 25 * $2 $4 * 25 $20 Net Profit [Pre-Tax Net Profit – Tax] $6 Tax $26 Pre-Tax Net Profit [Gross Profit – Total Fixed Cost] $24 Total Fixed Cost (Marketing) $50 Gross Profit [Revenue – Total Variable Cost] $50 Total Variable Cost [COGS + Other VC] $0 Other Variable Costs $50 COGS [Units Sold * Cost of Unit] $100 Revenue [Unit Sale Price * Units Sold] 25 Total Units Sold $4 Sale Price of unit $2 Cost of Each unit

Tax

Total Fixed Cost (Marketing)

Total Variable Cost [COGS + Other VC]

Other Variable Costs

COGS [Units Sold * Cost of Unit]

Specifics: Break-even Units $20 $26 - $6 Net Profit [Pre-Tax Net Profit – Tax] $6 Tax $24 Total Fixed Cost (Marketing) $26 $50 - $24 Pre-Tax Net Profit [Gross Profit – Total Fixed Cost] $50 + $0 $50 Total Variable Cost [COGS + Other VC] 25 * $2 $50 COGS [Units Sold * Cost of Unit] $0 Other Variable Costs Sum Calculation Price Item Description $24/$2 $50/25 $100 * $50 $4 * 25 $12 Break-even Units = Fixed Operating Cost/Gross Profit Per Unit $2 Gross Profit Per Unit = Total Gross Profits/Units Sold $50 Gross Profit [Revenue – Total Variable Cost] $100 Revenue [Unit Sale Price * Units Sold] 25 Total Units Sold $4 Sale Price of unit $2 Cost of Each unit

Tax

Total Fixed Cost (Marketing)

Total Variable Cost [COGS + Other VC]

COGS [Units Sold * Cost of Unit]

Other Variable Costs

Change in Units Sold $12 $24/$2 Break-even Units = Fixed Operating Cost/Gross Profit Per Unit $0 $0 - $0 Net Profit [Pre-Tax Net Profit – Tax] $0 Tax $0 $24 - $24 Pre-Tax Net Profit [Gross Profit – Total Fixed Cost] $24 Total Fixed Cost (Marketing) $24 + $0 $24 Total Variable Cost [COGS + Other VC] $0 Other Variable Costs 12 * $2 $24 COGS [Units Sold * Cost of Unit] Sum Calculation Price Item Description $24/12 $48 - $24 $4 * 12 $2 Gross Profit Per Unit = Total Gross Profits/Units Sold $24 Gross Profit [Revenue – Total Variable Cost] $48 Revenue [Unit Sale Price * Units Sold] 12 Total Units Sold $4 Sale Price of unit $2 Cost of Each unit

Tax

Total Fixed Cost (Marketing)

Total Variable Cost [COGS + Other VC]

Other Variable Costs

COGS [Units Sold * Cost of Unit]

At break-even point Business operates at no profit and no loss Any unit sold below the break-even units will bring loss to business, and Any unit sold above the break-even units will bring profit to business

Business operates at no profit and no loss

Any unit sold below the break-even units will bring loss to business, and

Any unit sold above the break-even units will bring profit to business

Note: Costs Mostly all business's costs fall into Variable costs increase directly in proportion to the level of sales in dollars or units sold. change in proportion to the activity of a business sometimes referred to as unit-level costs since they vary with the number of units produced. Examples: cost of goods sold (COGS), sales commissions, shipping charges, delivery charges, costs of direct materials or supplies, wages of temporary or part time employees, bonuses Fixed costs Stays same regardless of level of sales Examples: marketing related, rent, insurance, equipment expenses, business licenses, salary of permanent full time employees Variable and Fixed costs combined = Total Costs Element of dependency – normal costs Remains, no dependency

Mostly all business's costs fall into

Variable costs

increase directly in proportion to the level of sales in dollars or units sold.

change in proportion to the activity of a business

sometimes referred to as unit-level costs since they vary with the number of units produced.

Examples: cost of goods sold (COGS), sales commissions, shipping charges, delivery charges, costs of direct materials or supplies, wages of temporary or part time employees, bonuses

Fixed costs

Stays same regardless of level of sales

Examples: marketing related, rent, insurance, equipment expenses, business licenses, salary of permanent full time employees

Variable and Fixed costs combined = Total Costs

Total Costs Fixed Costs Variable Costs Total Costs Of Production Total Revenue & Cost Total Variable Costs Total Fixed Costs Loss Profit Break even Point Revenue UNITS $ More Higher

Note on Break-even … it requires estimating a single per-unit variable cost, and a single per-unit price or revenue, for the entire business .. it is hard to do in a business that has a collection of products or services to sell

… it requires estimating a single per-unit variable cost, and a single per-unit price or revenue, for the entire business

.. it is hard to do in a business that has a collection of products or services to sell

In a nut shell… In the "REAL WORLD" true costs are difficult to calculate there are so many things that can go wrong mistakes that happen in production All of which skew the figures Break-even analysis is sometimes difficult to calculate there is nothing in mathematics that allows for calculating the "COMPETITIVE ENVIRONMENT" This is why competition may cause you to make change to lower your price , or the demand may change which means you will have to change your calculation about WHEN you break even!

In the "REAL WORLD" true costs are difficult to calculate

there are so many things that can go wrong

mistakes that happen in production

All of which skew the figures

Break-even analysis is sometimes difficult to calculate

there is nothing in mathematics that allows for

calculating the "COMPETITIVE ENVIRONMENT"

This is why competition may

cause you to make change to lower your price , or

the demand may change

which means

you will have to change your calculation

about WHEN you break even!

Example 2: Calculation Formula: P=U(p-V)-F (P= Profit, p=price, U=units sold, V= variable costs and F=fixed costs) Selling Price (p)= $10.00, Units Sold (U) = 1,000 Assume Total fixed costs (F) = $7,700, Total variable costs (V) = $4.50/unit To Calculate Profit P=1,000($10.00 - $4.50) - $7,700 = $5,500 - $7,700 = -$2,200 P=$5,500 - $7,700 = -$2,200 What happened? Instead of making money we have just lost $2,200. At break even the $2,200 number should be $0. We can't make money at 1,000 units, so how many must we really sell to break even? Fixed costs (F) are $7,700, and the price (p) is still $10.00 and our variable costs (V) are $4.50/unit This is what we need to do: (p) price minus (V) variable costs divided into (F) fixed costs; ((p) – (V))/F $10.00 - $4.50 = $5.50 divided into $7,700 = 1,400 units Validate $1,400($5.50) = $7,700-$7,700 = $0 If we maintain our price/expenses, we need to sell 1,400 units of our product to break even. Note: If we raise our price or reduce expenses we can sell less.

Formula: P=U(p-V)-F

(P= Profit, p=price, U=units sold, V= variable costs and F=fixed costs)

Selling Price (p)= $10.00, Units Sold (U) = 1,000

Assume Total fixed costs (F) = $7,700, Total variable costs (V) = $4.50/unit

To Calculate Profit

P=1,000($10.00 - $4.50) - $7,700 = $5,500 - $7,700 = -$2,200

P=$5,500 - $7,700 = -$2,200

What happened?

Instead of making money we have just lost $2,200.

At break even the $2,200 number should be $0.

We can't make money at 1,000 units, so how many must we really sell to break even?

Fixed costs (F) are $7,700, and the price (p) is still $10.00 and our variable costs (V) are $4.50/unit

This is what we need to do:

(p) price minus (V) variable costs divided into (F) fixed costs; ((p) – (V))/F

$10.00 - $4.50 = $5.50 divided into $7,700 = 1,400 units

Validate

$1,400($5.50) = $7,700-$7,700 = $0

If we maintain our price/expenses, we need to sell 1,400 units of our product to break even.

Note: If we raise our price or reduce expenses we can sell less.

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