BreakEven and CostVolume Profit Analysis Chapter 24 Breakeven

Break-Even and Cost-Volume. Profit Analysis Chapter 24

Break-even Analysis n n 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 n n 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 n Break-even analysis may be based on ¡ ¡ Historical data Future sales and costs

Determining the Break-Even Point n 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 n The ABC Lodge has sales of $4500, 000. The fixed expense was $1, 200, 000 and the variable expense totaled $1, 800, 000. n Contribution margin ratio Contribution margin n

Income Statement n n n Sales Less variable expenses Total contribution margin Less fixed expenses Profit xxx xxx xxx

Determining the Break-Even Point Break-even = sales volume ($) Fixed costs Contribution margin ratio 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 n The ABC Lodge has sales of $4500, 000. The fixed expense was $1, 200, 000 and the variable expense totaled $1, 800, 000. n Break even point in dollars

Equation Approach n Profit= Sales revenue-variable expenses-fixed expenses n 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 n n n n Changes in Fixed expenses Original estimate Fixed utilities expenses $1, 400 Total Fixed expenses 48, 000 new estimate $2, 600 49, 200 Breakeven calculation 48, 000 (FC/unit contribution margin) $6 49, 200 $6 Break even point(units) Break even point (dollars) 8, 200 units $131, 200 8, 000 units $128, 000

Break even Chart n Change in unit variable expenses n Increase in unit variable expenses will cause a decrease in unit contribution margin. n Break even will now be achieved at a higher output level.

Break even Chart n Change in sales price n Increase in sales price will cause an increase in unit contribution margin. n Break even will now be achieved at a lower output level. n 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 n We can use break-even analysis to find the sales required to reach a target level of profit. n Number of sales units required to earn target profit: = Fixed expenses+ Target net profit Unit contribution margin n

Example n n n 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 n Example: ¡ ¡ n Fixed costs = $1, 600, 000 Sales = $5, 000 Sales/unit = $4 Variable cost/unit = $2. 4/unit Construct Break-even chart