3. The theory behind the breakeven analysis
Made up of four basic concepts
Fixed costs- costs that do not change
Variable costs- costs that rise in proportion to production
(sales)
Revenue- the total income received
Profit- the money you have after subtracting fixed and
variable cost from revenue
4. What can it be used for?
Monthly expenses- use it to see if your income is
more then your expenses
Determine minimum price product can be sold for
Determine optimum price product can be sold for
Calculate effects of marketing programs on price
5. Breakeven formula
SP(X) = FC + VC(X) or TR = TC
F.C. = fixed costs
V.C. = variable costs per unit
X = volume of output (in units)
S.P. = price per unit
6. This chart shows that the breakeven point is where the
income and costs are equal
7. Breakeven formula cont.
If we rearrange the where the breakeven is X then
the formula looks like this.
BEQ = FC /( SP – VC)
Where, SP – VC = Contribution
Therefore, BEQ = FC / Contribution
Margin of Safety = Actual Sales - Breakeven Sales
This formula says that the breakeven point is
where the number of sales needed to make the cost
equal to the revenue.
8. Example
Lets say you own a business selling burgers
It costs $1.00 to make one burger
That’s your variable cost
You sell each burger for $2.80
That’s your price per unit
Your cost for rent, utilities, overhead, etc... is $100,000 per
month
That's your fixed cost
9. Example cont.
VC = $1.00 SP = $2.80
FC = $100,000
BEQ = F /( P – V)
BEQ = 100,000 / ( 2.80 - 1 )
BEQ = 100,000 / ( 1.80 )
BEQ = 55,555
To breakeven you would need to sell
55,555 burgers
10. Problem
You own a lemonade stand
It costs you $0.05 to make cup of lemonade
You sell your lemonade for $0.25
It cost you $50.00 to make the stand
How many cups of lemonade do you have to sell to
breakeven?
11. Answer
BEQ = FC /( SP – VC)
= 50 / ( .25 - .05 )
= 50/ ( .20 )
=250 units
Therefore, 250 cups of lemonade to be sold to reach
breakeven.
12. A Breakeven Analysis is a simple tool to use
to determine if you have priced your
product correctly
A Breakeven Analysis helps you calculate
how much you need to sell before you begin
to make a profit. You can also see how fixed
costs, price, volume, and other factors affect
your net profit.
13. Calculation of breakeven price:
Example:
ABC International wants to enter the market for
yellow one-sided widgets. The fixed cost of
manufacturing these widgets is $50,000, and the
variable cost per unit is $5.00. ABC expects to sell
10,000 of the widgets. What shall be the break even
price of the yellow one-sided widgets?
14. Calculation of breakeven price:
($50,000 fixed costs / 10,000 units) + $5.00
variable cost
= $10.00 break even price
Assuming that ABC actually sells 10,000 units in the
period, $10.00 will be the price at which ABC breaks
even.
Formula: BEP = (FC/Qty) + VC
15. Operating Leverage
Operating leverage is the ratio of a
company's fixed costs to its variable costs
Formula:
Operating Leverage =
[Quantity x (Price – VC per Unit)] /
Quantity x (Price - VC per Unit) - Fixed
Operating Cost
Q(P-VC)/Q(P-VC) -FC
16. Example:
A Company XYZ sold 1,000,000 widgets for $12 each. It has
$10,000,000 of fixed costs. (equipment, salaried personnel, etc.).
It only costs $0.10 per unit to make each widget.
Operating Leverage
= 1,000,000 *($12 - $0.10)
__________________________________________
[1,000,000*($12 - $0.10) ] – 10,000,000
= 6.26 or 626%
This means that a 10% increase in revenues should yield 62.6%
increase in operating income (10% * 6.26).
17. Why it Matters?
In a sense, operating leverage is a means to calculating
a company's breakeven point.
However, it's also clear from the formula that
companies with high operating leverage ratios can
essentially make more money from incremental
revenues than other companies, because they don't
have to increase costs proportionately to make those
sales
Accordingly, companies with high operating leverage
ratios are poised to reap more benefits from good
marketing, economic pickups, or other conditions that
tend to boost sales.
18. Why it Matters?
Likewise, however, companies with high operating
leverage are more vulnerable to declines in revenue,
whether caused by macroeconomic events, poor
decision-making, etc.
It is important to note that some industries require
higher fixed costs than others. This is why
comparing operating leverage is generally most
meaningful among companies within the same
industry, and the definition of a "high" or "low"
ratio should be made within this context.
