Calculate Break Even Point Principles of Cost Analysis and Management

Terminal Learning Objective Action: Calculate Break Even Point Condition: FM Leaders in a classroom environment working individually and as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for international Learners): Identify Assumptions Underlying Break Even Analysis Identify Key Variables in Break Even Equation from Scenario Conduct Problem Demonstration Exercises for Key Variable, Contribution Margin and Break Even Points.

What is Break Even? The Point at which Revenues = Costs Revenues above the breakeven point result in profit Revenues below the breakeven point result in loss May be measured in units of output or revenue dollars Represents a “Reality Check” Is this level of revenue reasonable? If not, what actions would yield a reasonable breakeven point?

Review Cost Terminology Fixed Costs - Costs that do not change in total with the volume produced or sold Variable Costs - Costs that change in direct proportion with the volume produced or sold Mixed Costs - A combination of fixed and variable costs Semi-variable Cost - Costs that change with volume produced, but not in direct proportion Fixed Costs - Costs that do not change in total with the volume produced or sold Variable Costs - Costs that change in direct proportion with the volume produced or sold Mixed Costs - A combination of fixed and variable costs Semi-variable Cost - Costs that change with volume produced, but not in direct proportion Fixed Costs - Costs that do not change in total with the volume produced or sold Variable Costs - Costs that change in direct proportion with the volume produced or sold Mixed Costs - A combination of fixed and variable costs Semi-variable Cost - Costs that change with volume produced, but not in direct proportion Fixed Costs - Costs that do not change in total with the volume produced or sold Variable Costs - Costs that change in direct proportion with the volume produced or sold Mixed Costs - A combination of fixed and variable costs Semi-variable Cost - Costs that change with volume produced, but not in direct proportion Fixed Costs - Costs that do not change in total with the volume produced or sold Variable Costs - Costs that change in direct proportion with the volume produced or sold Mixed Costs - A combination of fixed and variable costs Semi-variable Cost - Costs that change with volume produced, but not in direct proportion

Identify Assumptions The following are implied in the simple breakeven equation: A single product or service Clearly segregated fixed and variable costs Variable costs are linear on a per-unit basis If analyzing multiple products is desired: Use “$1 of Revenue” as the Unit -or- Use a weighted average unit

LSA #1 Check on Learning Q1. Why do we need assumptions? A1. Q2. How many products do we use in breakeven analysis? A2. Q1. Why do we need assumptions? A1. To simplify the analysis, following the Cost-Benefit and Materiality Constraints. Q2. How many products do we use in breakeven analysis? A2. Only one. Multiple products can overly complicate the analysis. Facilitator’s Note: If time allowed, ask the following two questions. 1. Which type of cost remains the same in total when units produced or sold increases? 2. Which type of cost remains the same per unit when units produced or sold increases?

LSA #1 Summary LSA #1 summary will be given upon completion of LSA#4.

The Breakeven Equation Revenue – Costs = Profit Revenue - Variable Cost - Fixed Cost = Profit Breakeven Point is where Profit = 0 Revenue - Variable Cost - Fixed Cost = 0 Revenue = Variable Cost + Fixed Cost Revenue = #Units Sold * Selling Price $/Unit Variable Cost = #Units Sold * Variable Cost $/Unit Revenue – Costs = Profit Revenue - Variable Cost - Fixed Cost = Profit Breakeven Point is where Profit = 0 Revenue - Variable Cost - Fixed Cost = 0 Revenue = Variable Cost + Fixed Cost Revenue – Costs = Profit Revenue - Variable Cost - Fixed Cost = Profit Revenue – Costs = Profit

Graphic Depiction of Breakeven Units Sold

Graphic Depiction of Breakeven (Cont.) Units Sold

Graphic Depiction of Breakeven (Cont.) $ Units Sold

Graphic Depiction of Breakeven (Cont.) $ Units Sold

Graphic Depiction of Breakeven (Cont.) $ Units Sold

Graphic Depiction of Breakeven (Cont.) $ Units Sold

Graphic Depiction of Breakeven (Cont.) $ Units Sold

LSA #2 Check on Learning Q1. How is the breakeven equation expressed? A1. Q2. Which variables are represented on the graph by upward sloping lines? A2. Q1. How is the breakeven equation expressed? A1. Revenue – Cost = Profit Q2. Which variables are represented on the graph by upward sloping lines? A2. Total Cost, Variable Cost and Revenue

LSA #2 Summary LSA #2 summary will be given upon completion of LSA#4.

Sample Problem The following costs are incurred per show at Sebastian’s Dinner Theater: Facilities cost $500 Staff (actors who double as servers) 1000 Kitchen staff 200 Stage crew 300 Food cost (per ticket) 10 Ticket Price is $30 Task: Calculate Breakeven number of tickets.

Solving the Problem (part 1) Identify the key variables in the equation What are the fixed costs? Facilities cost 500 Staff (actors who double as servers) 1000 Kitchen staff 200 Stage crew 300 Total 2000 What are the variable costs? $10 Food/Ticket * #Tickets What is the revenue? $30 Price/Ticket * #Tickets Identify the key variables in the equation What are the fixed costs? Facilities cost 500 Staff (actors who double as servers) 1000 Kitchen staff 200 Stage crew 300 Total 2000 What are the variable costs? $10 Food/Ticket * #Tickets What is the revenue? $30 Price/Ticket * #Tickets Identify the key variables in the equation What are the fixed costs? Facilities cost 500 Staff (actors who double as servers) 1000 Kitchen staff 200 Stage crew 300 Total 2000 What are the variable costs? $10 Food/Ticket * #Tickets What is the revenue? $30 Price/Ticket * #Tickets Identify the key variables in the equation What are the fixed costs? Facilities cost 500 Staff (actors who double as servers) 1000 Kitchen staff 200 Stage crew 300 Total 2000 What are the variable costs? $10 Food/Ticket * #Tickets What is the revenue? $30 Price/Ticket * #Tickets

Define Contribution Margin Contribution Margin = Sales – Variable Cost Unit Contribution Margin Represents the dollar amount that each unit sold Contributes toward profit Unit Contribution Margin = Selling Price $/Unit – Variable Cost $/Unit What is the Unit Contribution Margin for Sebastian’s Dinner Theater? For every ticket sold, profit increases by: $30 - $10 = $20 Contribution Margin = Sales – Variable Cost Unit Contribution Margin Represents the dollar amount that each unit sold Contributes toward profit Unit Contribution Margin = Selling Price $/Unit – Variable Cost $/Unit What is the Unit Contribution Margin for Sebastian’s Dinner Theater? For every ticket sold, profit increases by: $30 - $10 = $20 Contribution Margin = Sales – Variable Cost Unit Contribution Margin Represents the dollar amount that each unit sold Contributes toward profit Unit Contribution Margin = Selling Price $/Unit – Variable Cost $/Unit What is the Unit Contribution Margin for Sebastian’s Dinner Theater? For every ticket sold, profit increases by: $30 - $10 = $20 Contribution Margin = Sales – Variable Cost Unit Contribution Margin Represents the dollar amount that each unit sold Contributes toward profit Unit Contribution Margin = Selling Price $/Unit – Variable Cost $/Unit What is the Unit Contribution Margin for Sebastian’s Dinner Theater? For every ticket sold, profit increases by: $30 - $10 = $20

Define Contribution Margin (Cont.) Contribution Margin may be stated as a Percentage: Unit Contribution Margin/Unit Selling Price Sebastian’s Contribution Margin Percentage = $20/$30 = $20/$30 = approximately .67 or 67% For every $1 of sale, profit will increase by approximately $.67

Solving the Problem (part 2) Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 $20(#Tickets) = $2000 #Tickets = $2000/$20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 $20(#Tickets) = $2000 #Tickets = $2000/$20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 $20(#Tickets) = $2000 #Tickets = $2000/$20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 $20(#Tickets) = $2000 #Tickets = 2000/20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 20(#Tickets) = 2000 #Tickets = 2000/20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 (30-10)(#Tickets) – 2000 = 0 20(#Tickets) – 2000 = 0 20(#Tickets) = 2000 #Tickets = 2000/20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 20(#Tickets) – 2000 = 0 20(#Tickets) = 2000 #Tickets = 2000/20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 20(#Tickets) = 2000 #Tickets = 2000/20 #Tickets = 100 Revenue – Variable Cost – Fixed Cost = Profit Breakeven is the point where Profit = 0 $30(#Tickets) – $10(#Tickets) – $2000 = $0 ($30-$10)(#Tickets) – $2000 = $0 $20(#Tickets) – $2000 = $0 20(#Tickets) = 2000 #Tickets = 2000/20 #Tickets = 100

Graphic Solution $ Units Sold

$30(#Tickets) – $10(#Tickets) – $2000 = $0 Proving the Solution Plug solution into the original equation: $30(#Tickets) – $10(#Tickets) – $2000 = $0 $30(100) – $10(100) – $2000 = $0 $3000 – $1000 – $2000 = $0

LSA #3 Check on Learning Q1. Is this quantity reasonable? A1. Q2. If not, why not? A2. Since the purpose of breakeven analysis is feasibility, now that the breakeven number of tickets is known, we should ask ourselves questions about feasibility. Q1. Is this quantity reasonable? A1. Can we reasonably expect to sell this number of tickets? Q2. If not, why not? A2. The most critical reason “why not” is capacity. Does the facility even hold 100 attendees? Can we cook and serve food for 100 attendees? Another reason to consider is demand. If there is not sufficient demand, is there anything we can do, such as advertising, to increase demand.

LSA #3 Check on Learning (Cont.) Q3. Does the Unit Contribution Margin appear in the Breakeven Equation? A3. Q4. Using Sebastian’s Dinner theatre data how many tickets must be sold to yield a profit of $500 per show? A4. Q5. $1000 per show? A5. Q3. Does the Unit Contribution Margin appear in the Breakeven Equation? A3. Yes. Contribution margin = Revenue – Variable Cost. Breakeven Equation = Revenue – Variable Cost – Fixed Cost Q4. How many tickets must be sold to yield a profit of $500 per show? A4. Equation set up: Use the Breakeven equation, replacing “0” with the target profit number. 30(#Tickets) - 10(#Tickets) – 2000 = 500 Note: The solution to the equation follows. (30-10)(#Tickets) – 2000 = 500 20(#Tickets) – 2000 = 500 20(#Tickets) = 2500 #Tickets = 2500/20 #Tickets = 125 Not surprisingly the additional number of tickets required above breakeven (100) is 25. Since the desired profit is 500 and the contribution margin is 20, profit will increase by 20 per ticket sold. Q5. $1000 per show? A5. 30(#Tickets) - 10(#Tickets) – 2000 = 1000 (30-10)(#Tickets) – 2000 = 1000 20(#Tickets) – 2000 = 1000 20(#Tickets) = 3000 #Tickets = 3000/20 #Tickets = 150

LSA #3 Summary During this lesson, we studied and talked about; LSA #1 Identify Assumptions Underlying Break Even Analysis •We What is Break Even •Revenues / Cost •Fixed Rates / Variable Cost / Mixed Cost / Semi-variable Cost •Why we need Assumptions LSA #2 Identify Key Variables in Break Even Equation from Scenario •Scenarios utilizing Break Even equation LSA #3 Conduct Problem Demonstration Exercises for Key Variable, Contribution Margin and Break Even Points. •Conducted several sample exercises dealing with Contribution Margin and Break Even Points.

Using the Breakeven Worksheet Enter Data from Practical Exercises in Spaces Provided Use Tabs to Navigate

Using the Breakeven Worksheet (Cont.) “Breakeven Point” Tab shows Graphic Solution and Proof Calculation

Using the Breakeven Worksheet (Cont.) Blue Area indicates Contribution Margin at Various Quantities

Using the Breakeven Worksheet (Cont.) “Cost” Tab Details Fixed Cost, Variable Cost, and Total Cost

Practical Exercise / Review

TLO Summary Action: Calculate Break Even Point Condition: FM Leaders in a classroom environment working individually and as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for international Learners): Identify Assumptions Underlying Break Even Analysis Identify Key Variables in Break Even Equation from Scenario Conduct Problem Demonstration Exercises for Key Variable, Contribution Margin and Break Even Points.