Copyright © 2000 by M. Ray Gregg. All rights reserved. 1

2 Break-Even Analysis

Copyright © 2000 by M. Ray Gregg. All rights reserved. 3 Objectives Determine the Break-Even Point in dollars in units Determine Target Net Income Prepare a Break-Even Chart Determine the Margin of Safety in dollars as a ratio (percentage) Determine the Contribution Margin Ratio

Copyright © 2000 by M. Ray Gregg. All rights reserved. 4 ??? Question ??? You paid $5,000 for a car, drove it 6 months and sold it to a friend for $5,000. How did you do? Gained how much?

Copyright © 2000 by M. Ray Gregg. All rights reserved. 5 Break-Even Point the level of sales at which total revenue is (exactly) equal to total costs and expenses

Copyright © 2000 by M. Ray Gregg. All rights reserved. 6 Break-Even Formula Sales = Fixed Costs + Variable Costs The Unknown $$ Dollars $$ % of Sales the level of sales at which total revenue is (exactly) equal to total costs and expenses

Copyright © 2000 by M. Ray Gregg. All rights reserved. 7 Break-Even Formula

Copyright © 2000 by M. Ray Gregg. All rights reserved. 8 Break-Even Formula

Copyright © 2000 by M. Ray Gregg. All rights reserved. 9 Break-Even Formula

Copyright © 2000 by M. Ray Gregg. All rights reserved. 10 Break-Even Formula R E Net Income

Copyright © 2000 by M. Ray Gregg. All rights reserved. 11 Break-Even Formula R E Net Loss

Copyright © 2000 by M. Ray Gregg. All rights reserved. 12 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 13 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 14 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 15 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 16 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 17 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 18 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 19 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 20 Break-Even Formula R E Expenses Revenue

Copyright © 2000 by M. Ray Gregg. All rights reserved. 21 Break-Even Formula R E BREAK EVEN

Copyright © 2000 by M. Ray Gregg. All rights reserved. 22 Break-Even Formula R E BREAK EVEN

Copyright © 2000 by M. Ray Gregg. All rights reserved. 23 Break-Even Formula R E BREAK EVEN

Copyright © 2000 by M. Ray Gregg. All rights reserved. 24 Break-Even Formula R E BREAK EVEN

Copyright © 2000 by M. Ray Gregg. All rights reserved. 25 Break-Even Formula R E BREAK EVEN

Copyright © 2000 by M. Ray Gregg. All rights reserved. 26 Break-Even Formula R E BREAK EVEN

Copyright © 2000 by M. Ray Gregg. All rights reserved. 27 Break-Even Formula Sales = Fixed Costs + Variable Costs (BE point in TOTAL DOLLARS)

Copyright © 2000 by M. Ray Gregg. All rights reserved. 28 Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in dollars. Break-Even Formula Sales = Fixed Costs + Variable Costs Trap #1: Don’t fall for that trick! The Unknown $60, S S =

Copyright © 2000 by M. Ray Gregg. All rights reserved. 29 Break-Even Formula Sales = Fixed Costs + Variable Costs S = $60, S S –.60 S = $60,000 Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in dollars.

Copyright © 2000 by M. Ray Gregg. All rights reserved. 30 Break-Even Formula Sales = Fixed Costs + Variable Costs S = $60, S S –.60 S = $60, S = $60,000 Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in dollars.

Copyright © 2000 by M. Ray Gregg. All rights reserved. 31 Break-Even Formula Sales = Fixed Costs + Variable Costs S = $60, S S –.60 S = $60, S = $60,000 S = $150,000 Break-Even Point! Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in dollars.

Copyright © 2000 by M. Ray Gregg. All rights reserved. 32 Break-Even PROOF Sales (at BE)$150,000 Less: VC (60%) 90,000 Contribution Margin 60,000 Less: Fixed Costs 60,000 Net Income-0- Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in dollars. Income Statement

Copyright © 2000 by M. Ray Gregg. All rights reserved. 33 Break-Even in UNITS Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in units. BE $ $ unit selling price $150,000 $ $100 1,500 units to break-even

Copyright © 2000 by M. Ray Gregg. All rights reserved. 34 Do you want to break even?

Copyright © 2000 by M. Ray Gregg. All rights reserved. 35 NO!

Copyright © 2000 by M. Ray Gregg. All rights reserved. 36 Target Net Income What must sales be to increase net income by $20,000? What is net income presently???

Copyright © 2000 by M. Ray Gregg. All rights reserved. 37 Income Statement Sales$200,000 VC (60%)$120,000 FC 60, ,000 Net Income$ 20,000

Copyright © 2000 by M. Ray Gregg. All rights reserved. 38 Target Net Income What must sales be to increase net income by $20, to $40,000? Sales$200,000. NI $ 20,000 Sales$200,000. NI $ 20,000 Increase by $20,000

Copyright © 2000 by M. Ray Gregg. All rights reserved. 39 Target Net Income What must sales be to increase net income by $20, to $40,000? Sales$200,000. NI $ 20,000 Sales$200,000. $220,000 NI $ 40,000

Copyright © 2000 by M. Ray Gregg. All rights reserved. 40 NO!

Copyright © 2000 by M. Ray Gregg. All rights reserved. 41 Target Net Income S = FC + VC + TNI S = $60, S + $40,000 S –.60S = $60,000 + $40,000.40S = $100,000 S = $250,000 What must sales be to increase net income by $20, to $40,000?

Copyright © 2000 by M. Ray Gregg. All rights reserved. 42 Income Statement Sales$250,000 VC (60%)$150,000 FC 60, ,000 Net Income$ 40,000

Copyright © 2000 by M. Ray Gregg. All rights reserved. 43 Break-Even Chart

Copyright © 2000 by M. Ray Gregg. All rights reserved. 44 Break-Even Chart Units Sold Dollars 100% Total Sales

Copyright © 2000 by M. Ray Gregg. All rights reserved. 45 Break-Even Chart Units Sold Dollars FC (FC+VC) TC? Break-Even Point Total Cost

Copyright © 2000 by M. Ray Gregg. All rights reserved. 46 Break-Even Chart Units Sold Dollars Income Loss

Copyright © 2000 by M. Ray Gregg. All rights reserved. 47 Margin of Safety W, K, & K: “…is the difference between actual … sales and sales at the break-even point.” p. 959

Copyright © 2000 by M. Ray Gregg. All rights reserved. 48 Break-Even Chart Units Sold Actual S S at BE Margin of Safety

Copyright © 2000 by M. Ray Gregg. All rights reserved. 49 How “Safe” Are You ??? Units Sold Actual S S at BE

Copyright © 2000 by M. Ray Gregg. All rights reserved. 50 Margin of Safety W, K, & K: “…is the difference between actual … sales and sales at the break-even point.” p RG & CW: “…is the excess of actual sales over sales at the break-even point.”

Copyright © 2000 by M. Ray Gregg. All rights reserved. 51 Break-Even Chart Units Sold Actual S S at BE Margin of Safety

Copyright © 2000 by M. Ray Gregg. All rights reserved. 52 Margin of Safety RG & CW: “…is the excess of actual sales over sales at the break-even point.” in dollars as a percentage

Copyright © 2000 by M. Ray Gregg. All rights reserved. 53 Margin of Safety RG & CW: “…is the excess of actual sales over sales at the break-even point.” MS $ =S A –S BE In dollars: As ratio: (S A – S BE ) S A MS % =

Copyright © 2000 by M. Ray Gregg. All rights reserved. 54 Previous Example Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Current Net Income is??? Break-even point is??? Compute the margin of safety in dollars and as a ratio.

Copyright © 2000 by M. Ray Gregg. All rights reserved. 55 Previous Example Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Current Net Income is$ 20,000 Break-even point is$150,000 Compute the margin of safety in dollars and as a ratio.

Copyright © 2000 by M. Ray Gregg. All rights reserved. 56 Previous Example Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Current net income is $20,000, and the break-even point is $150,000. Compute the margin of safety in dollars and as a ratio. MS $ =S A –S BE In dollars:

Copyright © 2000 by M. Ray Gregg. All rights reserved. 57 Previous Example Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Current net income is $20,000, and the break-even point is $150,000. Compute the margin of safety in dollars and as a ratio. MS $ = $200,000 –$150,000In dollars: As ratio: (S A – S BE ) S A MS % =

Copyright © 2000 by M. Ray Gregg. All rights reserved. 58 Previous Example Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Current net income is $20,000, and the break-even point is $150,000. Compute the margin of safety in dollars and as a ratio. MS $ = $200,000 –$150,000In dollars: As ratio: MS % = $50,000 $200,000 = 25%

Copyright © 2000 by M. Ray Gregg. All rights reserved. 59 Remember? Salesxx Less: COGS x Gross Profit x Then … GP / S = GP percentage 100% 40% 60% Salesxx Less: VC & VE x Contribution Margin x Then … CM / S = CM Ratio 100% 70% 30%

Copyright © 2000 by M. Ray Gregg. All rights reserved. 60 Contribution Margin Ratio Salesxx Less: VC & VE x Contribution Margin x 100% 70% 30% Contribution Margin Sales = CMR also complement of variable costs & exp

Copyright © 2000 by M. Ray Gregg. All rights reserved. 61 Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Previous Example What is the contribution margin ratio? 40%

Copyright © 2000 by M. Ray Gregg. All rights reserved. 62 Shortcuts Break-Even in Dollars S$=S$= FC $ CM Ratio

Copyright © 2000 by M. Ray Gregg. All rights reserved. 63 Break-Even Formula Sales = Fixed Costs + Variable Costs S = $60, S S –.60 S = $60, S = $60,000 Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in dollars.

Copyright © 2000 by M. Ray Gregg. All rights reserved. 64 Shortcuts Break-Even in UNITS SU=SU= FC $ Unit CM

Copyright © 2000 by M. Ray Gregg. All rights reserved. 65 Previous Example Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in units. SU=SU= FC $ Unit CM SU=SU= $60,000 $40 SU=SU=1,500 units

Copyright © 2000 by M. Ray Gregg. All rights reserved. 66 Break-Even in UNITS Actual sales for Company A are $200,000 ($100 each), fixed costs (and expenses) are $60,000 and variable costs (and expenses) are 60% of sales. Compute the break-even point in units. BE $ $ unit selling price $150,000 $ $100 1,500 units to break-even

Copyright © 2000 by M. Ray Gregg. All rights reserved. 67 Objectives Determine the Break-Even Point in dollars in units Determine Target Net Income Prepare a Break-Even Chart Determine the Margin of Safety in dollars as a ratio (percentage) Determine the Contribution Margin Ratio

Copyright © 2000 by M. Ray Gregg. All rights reserved. 68

Copyright © 2000 by M. Ray Gregg. All rights reserved. 69 Keep your life in balance this week!