Breakeven Analysis Part 1 Click here for Streaming Audio To Accompany Presentation (optional) Click here for Streaming Audio To Accompany Presentation (optional) EGR 403 Capital Allocation Theory Dr. Phillip R. Rosenkrantz Industrial & Manufacturing Engineering Department Cal Poly Pomona

EGR Cal Poly Pomona - SV32 EGR The Big Picture Framework: Accounting & Breakeven Analysis “Time-value of money” concepts - Ch. 3, 4 Analysis methods –Ch. 5 - Present Worth –Ch. 6 - Annual Worth –Ch. 7, 8 - Rate of Return (incremental analysis) –Ch. 9 - Benefit Cost Ratio & other techniques Refining the analysis –Ch. 10, 11 - Depreciation & Taxes –Ch Replacement Analysis

EGR Cal Poly Pomona - SV33 Introduction Break even (BE) analysis helps engineers understand the “big picture” Knowing how your project or assignment affects profitability can help you sell your projects to upper management Understanding BE analysis illustrates the value of engineers to the company

EGR Cal Poly Pomona - SV34 Recall from the P & L Statement Fixed costs - do not vary (e.g., lease costs, rent, insurance) Variable costs - vary with volume of production (e.g., labor, materials, supplies, rent, etc.) Overhead can also be applied here as a variable expense or burden rate. Profit Equation - Profit = Revenue - Expenses

EGR Cal Poly Pomona - SV35 Breakeven Volume Total Variable Cost (VC) is a function of volume (x) of units sold. Total VC = Variable Cost/unit * x Total Cost = Fixed Cost + Total VC Revenue is also a function of units sold: Revenue = Price/unit * x Breakeven Volume is the number of units you need to sell so that: Revenue = Total Cost

EGR Cal Poly Pomona - SV36 Breakeven Volume (cont’d) Find x such that: Price/unit * x = Fixed + VC/unit * x Therefore: x BE = Fixed Cost / (Price/unit - VC/unit) If actual volume is < x BE, you have a loss If actual volume is > x BE, you have a profit

EGR Cal Poly Pomona - SV37 Fixed Cost Fixed cost is the the same, regardless of volume

EGR Cal Poly Pomona - SV38 Variable Cost + Fixed Cost Total Cost goes up with volume because Variable Cost increases

EGR Cal Poly Pomona - SV39 Total Revenue is based on volume and selling price/unit. Where the Revenue and Total Cost lines intersect is the Break Even (BE) Point. That volume is the BE Volume

EGR Cal Poly Pomona - SV310 Profit Above the BE point, the difference between the Revenue and Total Cost lines represents profit

EGR Cal Poly Pomona - SV311 Loss If volume is below the BE point, the difference between the lines represents a loss

EGR Cal Poly Pomona - SV312 Break Even Analysis Collect financial and cost information to determine fixed and variable costs –Fixed costs –Variable cost/unit (labor, materials, overhead) Estimate Selling Price per unit from marketing analysis and market testing Determine BE volume and compare to estimated sales If estimated sales volume is not above the BE volume, make adjustments