Breakeven point analysis
Also know as "CVP" Cost-Volume-Profit Analysis:
The basic idea: you must cover all of your costs before you can make a profit. But, some costs behave differently than others.
Table of Contents:
Why use a Breakeven analysis?:
1. When deciding whether or not to add a new product or service
2. To see what volume you have to sell to make a profit (is it realistic?)
3. To see how much operating leverage you are using.
4. To decide how much to charge for your service
5. As part of a sensitivity analysis to see how your profit margin is to changes in variable and fixed costs.
6. To see what would happen if you would raise or lower your prices...
7. Product mix decisions...
Process:
note: The easiest way to do this is to work on a "per unit basis". How much revenue PER UNIT sold - cost per unit = CM per unit...etc...
1. Find your revenues (per unit)
2. what are your variable costs
3. Subtract V.C from revenue to get your contribution margin This will tell you that each unit you sell will contribute $(x) to covering your fixed costs.
from here, if you subtract your fixed costs, you will find your profits. (The breakeven point is when the profits =0)
4. now try to figure out the volume that makes your total contribution = to your total fixed costs
how?
5. Basic algebra needed here: pick some variable (x) and call that your volume at breakeven (assume you are at the B.E.P, and that (x) is the volume)
6. So, (x) time the contribution margin = fixed costs
7. Solve for (x)
Formula
One way to do it:
Another way to do it:
Using BEP for Making marketing decisions:
Breakeven analysis
You absolutely can NOT make a marketing plan that does not include a break even analysis!!!
In high fixed costs businesses, you need to expand market share at all costs. There is an Optimal point that you need to consider.
Capacity utilization and operating profit are related….you need both. Need capacity utilization to drive down cost per unit…fixed costs must be covered to get operation profits.
For example, when shipping cachaca from Brazil, what are our fixed costs we need to cover? The key to exporting is in your ability to cover your fixed costs of the sea container. Lets say it costs $5,000 for each container that gets sent from Brazil to Spain ....thats your fixed cost.... how can we use this info to make breakeven analysis.
How to find the needed numbers
Using the Variable income statement to determine the break-even point, and the operating leverage
When looking at a proposed project, it is useful to conduct a breakeven analysis to see how many units must be sold to cover your fixed costs. This "job order costing" is done to figure out the amount of risk there is in the project.
The first thing you need to do is to make a Variable income statement, and figure out what is the contribution margin (revenues - variable costs). You then subtract all of your fixed costs to come up with your operating income. Subtract taxes to get your net income. The goal is to make sure that you have enough contribution margin from this one project to cover your fixed costs of taking on this project (but please just consider only the relevant fixed costs for this project, and do not include non-relevant cash flows).
The "indifference point" is where the project breaks even, ie where contribution margin just barely covers the fixed costs.
The risk of the project is determined by the operating leverage (contribution margin / net income). the higher the operating leverage, the more risk of the project (or firm). This is because if you take on additional debt (fixed interest costs), then the gap between C.M and N.I will be higher, which will result in a higher operating leverage ratio. (net income will decrease with additional fixed expenses, but C.M stays high, so the ratio of CM / NI will be larger with added fixed costs).
This ratio is extremely useful when comparing two projects (or two companies). The one with the higher operating leverage will show much higher returns at higher volumes of sales, but will suffer much larger losses at lower volume of sales. We call it "leverage" because of the amplification effect.
Variable Income statement
Revenues
-All Variable costs:
VMCGS (variable manufacturing COGS) *does not include FFO
VS&A (variable sales and admin costs)
____
C.M. (contribution margin)
-All Fixed costs
FFO (fixed factory overhead)
FS&A (fixed sales and admin)
___
Operating Income
- taxes
___
Net Income
This is different than the standard Gross Margin income statement that companies normally use when reporting (based on absorption costing). The Gross Profit income statement is different in that it combines all inventoriable costs into the COGS figure at the top (FFO is included in the COGS when the firm sells the products), and it also shows all S&A expenses as period costs at teh bottom of the Income statement, as shown here:
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