Break-Even Analysis Shad Valley Entrepreneurship

Break - Even Analysis  This is a planning and/or control technique.  PLANNING:  make informed decisions about pricing your product or service and the cost to produce it.  CONTROL:  Determine your progress towards a goal  ie compare real sales with predicted

Revenue, Profit, Costs  Price Per Unit – What you will sell one item for  Revenue – Money from sales  Revenue = (Price Per Unit * Number of units sold)  Cost – Money you have to pay to produce/market/sell your product  Profit = Revenue - Cost

Fixed vs Variable Cost  Fixed Costs  costs that DO NOT change in response to changes in sales volume.  rent, salaries, utilities, etc.  Variable Costs  costs that DO change in response to changes in sales volume.  Examples include direct materials and direct labour costs (wages paid by hour).  Profit = Revenue – (Fixed Costs + Variable Costs)

Breakeven Point and Contribution Margin  Breakeven Point: The number of units a company must sell in order to cover their costs, both fixed and variable  Contribution Margin: Amount of revenue per unit after variable costs have been accounted for  The break-even point can be found using the following equation:  Breakeven Point = Fixed Costs / Contribution Margin OR  Breakeven Point = Fixed Costs / (Selling price per unit - Variable Cost per unit)

Number of units produced and sold $ per unit Total Revenue Line 1 2 $20 $10 Sales revenue when price per unit is $ Revenue

Total Revenue Line 1 2 $20 $10 Sales revenue when price per unit is $5.00. Number of units produced and sold $ per unit Revenue

Total Revenue 1 2 $7.50 $10 If variable cost per unit is less than price per unit, there is a positive contribution margin. Total Variable Cost Contribution Margin per unit = $2.50 Number of units produced and sold $ per unit Contribution Margin

Calculating Contribution Margin  You plan to start a bagel shop. The average customer will purchase a dozen bagels, some cream cheese and a coke. You have determined that your variable costs to produce this ‘average customer purchase’ as follows:  Contribution Margin = $ $8.99 = $1.51 Variable Cost per unit Coke and cup$ Bagels cooked (materials and electricity)2.99 Cream cheese and container1.65 Straw/napkins/bag and other condiments0.75 Direct labour costs (counter help & cook)2.75 Total variable cost per unit$8.99 Price Per Unit Coke$2.00 Doz Bagels w/Cream Cheese8.50 Total Cost to Customer$10.50

Contribution Margin Analysis  Now that you know your variable costs, price, and your contribution margin, ask yourself these questions:  Given my competitors pricing, can I profitably compete with my competition?  Can I lower my variable costs per unit?  Can I change if environmental conditions (competition etc) change in the future?  Can I compete on a differentiated strategy (higher quality, etc)?  Can I compete on any of the other 4 Ps  ProductPhysical Evidence*  PromotionPeople*  PlaceProcess* * For service businesses

Break Even Point  Now we consider fixed costs  Once those fixed costs are covered, any further units that are sold will result in profit….  Breakeven Point - where total revenue equals to total costs  Variable and Fixed costs are summed to equal total costs.  Break even point (units) = Annual Fixed Costs / contribution margin

Break Even Chart Total Revenue Total Costs Fixed Costs TR = TC Number of units produced and sold $ per unit Break Even Point in Units

Annual Fixed Costs  Now consider the fixed costs: Fixed Costs Annual building lease costs (12 $2,000/month) $24, Office expenses (bank charges, accountant etc.) $8, Depreciation of equipment (ovens, microwave, etc.) $4, Gross Salary for the manager $34, Employer contribution to CPP/EI and employer health tax $9, Other fixed costs (advertising and promotion) $2, TOTAL ANNUAL FIXED COSTS $81,650.00

Break Even Point  The breakeven point, given your analysis to this point is: Break-even point in #’s of units annually = = Annual Fixed Costs / Contribution Margin = $81,650 / $1.51 = 54,073 meals per year An average of 54,073/365 = 149 units per day. If you sell more than 54,073 units a year, this is NET PROFIT! If you sell less, then you have a NET LOSS.

Break Even Point  Must sell 149 * 12 = 1,788 bagels a day, on average  Do you have the capacity?  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.  What is the market for your product in that location?  Who would buy bagels?  How frequently?  What is their purchasing behavior?  Attitudes toward price?

Break Even Point  Break-even point= 54,073 units  At an average price per sale of $10.50, that volume of meals means annual sales revenue of: Annual Sales Revenue = Price per unit * # sold = $10.50 * 54,073 = $567,766.50

Relevant Range  The relevant range is the range of output (units produced and sold) that the cost and pricing assumptions can reasonably be expected to hold. $ of Sales and Costs # of units produced and sold Total Revenue Total Costs (Fixed + Var) Fixed Costs Relevant Range

Relevant Range – Adding Capacity  What if we have to add new equipment to keep up with demand? Our Fixed Costs increase! $ of Sales and Costs # of units produced and sold Total Revenue Total Costs Fixed Costs Relevant Range

Conveying Financial Results  Spreadsheets  Tables  Graphs  Product lines as a percentage of total sales (pie chart)  Sales by geographic regions  Sales Revenue Projections (trends illustrated through a line or bar chart)  Sales volume (units sold)  Net earnings  Expenses (bar charts)

Exercise – Perform a Break Even Analysis in Groups 1. Identify your variable costs per unit (Slide 4, 9). 2. Identify your price structure per unit (Slide 4, 9). 3. Calculate your contribution margin (8, 9). 4. Perform a contribution margin analysis (Slide 10). 5. Identify your fixed costs per year (Slide 13). 6. Determine your break even point per year, average per day, and breakeven annual sales revenue. Consider the hours of business and the days your business will be open (Slide 14-16). 7. Consider your market, sales forecasts, and capacity! (Slide 15) Is your situation favourable? 8. Answer this simple question: “Should you be in this business?”