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# Break even points

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• ### Break even points

1. 1. Break-even Analysis Shad Valley 2007
2. 2. Break - Even Analysis (Cost/Volume/Profit Analysis) <ul><li>This is a planning and control technique. </li></ul><ul><li>PLANNING: </li></ul><ul><ul><li>make informed decisions about pricing your product or service and the cost to produce it. </li></ul></ul><ul><li>CONTROL: </li></ul><ul><ul><li>compare your actual results with those that you have forecast. (For example, your restaurant may require you to sell 10,000 meals at \$10.00 per meal = \$100,000 in order to break even annually. This works out to 192 meals a week or 28 per day. If on the first day of operation you sell 30 meals…you are on track to break even!) </li></ul></ul>
3. 3. Break - Even Analysis (Cost/Volume/Profit Analysis) <ul><li>The break-even point can be found using the following equation: </li></ul><ul><li>B.E. Point = Fixed Costs </li></ul><ul><li>Contribution Margin </li></ul><ul><li>= Fixed Costs </li></ul><ul><li>Selling price/unit - Variable Cost/unit </li></ul>
4. 4. Cost Behaviour <ul><li>You can classify fixed and variable costs according to how they change in response to changes in sales volume. </li></ul><ul><li>Fixed Costs </li></ul><ul><ul><li>are costs that (within the relevant range) don’t change in response to changes in sales volume. </li></ul></ul><ul><ul><li>Examples include depreciation expense, rent, salaries and other overhead costs. </li></ul></ul><ul><li>Variable Costs </li></ul><ul><ul><li>are costs that (within the relevant range) change in response to changes in sales volume. </li></ul></ul><ul><ul><li>Examples include direct materials and direct labour costs (wages paid by hour). </li></ul></ul>
5. 5. Relevant Range <ul><li>The relevant range is the range of output (units produced and sold) that the cost and pricing assumptions can reasonably be expected to hold. </li></ul>\$ of Sales and Costs # of units produced and sold Total Revenue Total Costs Fixed Costs Relevant Range
6. 6. Relevant Range <ul><li>If sales are expected to push the firm beyond its current physical capacity, (beyond the relevant range) cost behaviour assumptions must be revised. </li></ul>\$ of Sales and Costs # of units produced and sold Total Revenue Total Costs Fixed Costs Relevant Range
7. 7. Break - Even Analysis (Cost/Volume/Profit Analysis) Number of units produced and sold \$ of Sales and Costs Total Revenue Line 1 2 \$20 \$10 The slope of the revenue line is determined by the price that you set for your product or service. Sales revenue when price per unit is \$10.00.
8. 8. Break - Even Analysis (Cost/Volume/Profit Analysis) Number of units produced and sold \$ of Sales and Costs Total Revenue Line 1 2 \$20 \$10 The slope of the revenue line is determined by the price that you set for your product or service. Sales revenue when price per unit is \$5.00.
9. 9. Break - Even Analysis (Cost/Volume/Profit Analysis) Number of units produced and sold Total Revenue Line \$7.50 \$10 Total Variable Cost Contribution Margin per unit = \$2.50 The slope of the revenue line is determined by the price that you set for your product or service. \$ of Sales and Costs 1 2 If variable cost per unit is less than price per unit, there is a positive contribution margin.
10. 10. Contribution Margin <ul><li>For most small businesses, it is relatively easy to determine the variable cost per unit. </li></ul><ul><li>What you want to determine is how much it costs you in terms of direct material and direct labour to produce your product or service. </li></ul><ul><li>Once you know the variable cost per unit, this becomes a good guide to you in the pricing decision. Obviously, if you price your product under your variable cost per unit, you will lose money each time you sell one unit. The more you sell, the more money you lose. </li></ul><ul><li>Look at the following example….. </li></ul>
11. 11. Contribution Margin Example <ul><li>You plan to start a bagel shop. </li></ul><ul><li>The average customer will purchase a dozen bagels, some cream cheese and a coke. </li></ul><ul><li>You have determined that your variable costs to produce this ‘average customer purchase’ as follows: </li></ul><ul><li>Variable Cost per unit </li></ul><ul><li>Coke and cup \$0.85 </li></ul><ul><li>12 Bagels cooked (materials and electricity) 2.99 </li></ul><ul><li>Cream cheese and container 1.65 </li></ul><ul><li>Straw/napkins/bag and other condiments 0.75 </li></ul><ul><li>Direct labour costs (counter help & cook) 2.75 </li></ul><ul><li>Total variable cost per unit \$8.99 </li></ul><ul><li>Given your analysis you initially price coke at \$2.00 and a dozen bagels with cheese for \$8.50 giving you a contribution margin of \$1.51 per unit. Total cost to the customer is \$10.50 plus PST and GST or \$12.08 </li></ul>
12. 12. Contribution Margin …. <ul><li>You now find out that the Great Canadian Bagel sells coke for \$1.75 and a dozen bagels with cheese for \$6.50 for a total cost to the customer of \$9.49 (including Gst and Pst)…this is below your estimated variable cost per unit! </li></ul><ul><li>The Great Canadian Bagel is a franchise that benefits by the fact that the franchisor has tremendous buying power (centrally negotiates purchases and prices with suppliers for flour, cream cheese and coke). This gives them a competitive advantage over you... </li></ul><ul><li>Variable Cost per unit Great Canadian Bagel </li></ul><ul><li>Coke and cup \$0.85 \$0.45 </li></ul><ul><li>12 Bagels cooked (materials and electricity) 2.99 1.50 </li></ul><ul><li>Cream cheese and container 1.65 1.20 </li></ul><ul><li>Straw/napkins/bag and other condiments 0.75 0.50 </li></ul><ul><li>Direct labour costs (counter help & cook) 2.75 2.75 </li></ul><ul><li>Total variable cost per unit \$8.99 \$6.40 </li></ul>
13. 13. Contribution Margin …. <ul><li>Conclusion: if you are to compete with the Great Canadian Bagel purely on price, you will fail. </li></ul><ul><li>Variable Cost per unit Great Canadian Bagel </li></ul><ul><li>Coke and cup \$0.85 \$0.45 </li></ul><ul><li>12 Bagels cooked (materials and electricity) 2.99 1.50 </li></ul><ul><li>Cream cheese and container 1.65 1.20 </li></ul><ul><li>Straw/napkins/bag and other condiments 0.75 0.50 </li></ul><ul><li>Direct labour costs (counter help & cook) 2.75 2.75 </li></ul><ul><li>Total variable cost per unit \$8.99 \$6.40 </li></ul><ul><li>Selling Price to the Public per unit \$10.50 \$8.25 </li></ul><ul><li>Contribution margin per unit \$1.51 \$1.85 </li></ul><ul><li>Your variable cost per unit is higher than the Great Canadian Bagels variable cost per unit. </li></ul><ul><li>Your proposed selling price is 27% higher than your competition yet your proposed contribution margin is 18% lower. </li></ul>
14. 14. Contribution Margin Analysis <ul><li>Faced with this pricing and costing analysis, you have some choices: </li></ul><ul><ul><li>forget about going into this business </li></ul></ul><ul><ul><li>seek to negotiate arrangements where your direct operating costs can be lowered </li></ul></ul><ul><ul><li>devise a product or marketing strategy that would induce consumers to purchase your products over the Great Canadian Bagel product (higher quality product, perceived greater value that justifies the higher price) </li></ul></ul><ul><ul><li>seek to locate your business somewhere there is no direct competition. (Nipigon, Marathon, Atikokan, Sioux Lookout) </li></ul></ul><ul><li>Of course, further analysis will be required (before proceeding) to determine whether you could actually make a profit at the business. </li></ul>
15. 15. Contribution Margin <ul><li>The contribution margin is the amount of money that is available from the sale of each unit to cover the fixed costs of the firm. </li></ul><ul><li>Once those fixed costs are covered, any further units that are sold will result in profit…. </li></ul>
16. 16. Break Even Point <ul><li>Is the point where total revenue equals to total costs </li></ul><ul><li>Variable and Fixed costs are summed to equal total costs. </li></ul><ul><li>Break even point in units = Annual Fixed Costs / contribution margin </li></ul>
17. 17. Break Even Chart \$ of Sales and Costs # of units produced and sold Total Revenue Total Costs Fixed Costs Break Even Point in Units TR = TC
18. 18. Annual Fixed Costs of the Bagel Business <ul><li>Let us assume for a moment that you have decided to locate your proposed business in Nipigon where you are sure that there is no competition, and it is unlikely competition would enter the market after you arrive. </li></ul><ul><li>You estimate that once established, you will face the following fixed costs each year to run the business: </li></ul><ul><li>Annual building lease costs (12 months @ \$2,000/month) \$24,000 </li></ul><ul><li>Office expenses (bank charges, accountant etc.) 8,000 </li></ul><ul><li>Depreciation of equipment (ovens, microwave, etc.) 4,400 </li></ul><ul><li>Gross Salary for the manager 34,000 </li></ul><ul><li>Employer contribution to CPP/EI and employer health tax 9,520 </li></ul><ul><li>Other fixed costs (advertising and promotion) 2,000 </li></ul><ul><li>TOTAL ANNUAL FIXED COSTS \$81,650 </li></ul>
19. 19. Break Even Point of the Bagel Business <ul><li>The breakeven point, given your analysis to this point is: </li></ul><ul><li>Break-even point in #’s of meals annually = Annual Fixed Costs </li></ul><ul><li>Contribution Margin </li></ul><ul><li>= \$81,650 </li></ul><ul><li> \$1.51 </li></ul><ul><li>= 54,073 meals </li></ul><ul><li>This works out to 4,507 meals per month or 149 meals per day. </li></ul>
20. 20. Break Even Point of the Bagel Business <ul><li>Break-even point = 54,073 meals </li></ul><ul><li>This works out to 4,507 meals per month or 149 meals per day. </li></ul><ul><li>This implies baking and selling 1,788 bagels per day with no wastage. </li></ul><ul><ul><li>Do your oven’s and facilities have the capacity to produce this volume each day? </li></ul></ul><ul><ul><li>If you are closed on Christmas, New Year’s or any other day…you will have to sell more on the other days on average. </li></ul></ul><ul><ul><li>NOW - the big question….what is the market for your product in that location…who would buy bagels? How frequently? What is their purchasing behaviour? Attitudes toward price? </li></ul></ul>
21. 21. Break Even Point of the Bagel Business <ul><li>Break-even point = 54,073 meals </li></ul><ul><li>At an average price per sale of \$10.50, that volume of meals means annual sales revenue of: </li></ul><ul><li>Annual Sales Revenue = Price per meal times # of meals </li></ul><ul><li>= \$10.50 * 54,073 </li></ul><ul><li>= \$567,766.50 </li></ul>