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. 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. 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 $60,000 +.60 S S =

Copyright © 2000 by M. Ray Gregg. All rights reserved. 29 Break-Even Formula Sales = Fixed Costs + Variable Costs S = $60,000 +.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 = $60,000 +.60 S S –.60 S = $60,000.40 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 = $60,000 +.60 S S –.60 S = $60,000.40 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. 38 Target Net Income What must sales be to increase net income by $20,000 -- 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 $20,000 -- 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. 41 Target Net Income S = FC + VC + TNI S = $60,000 +.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 $20,000 -- to $40,000?

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. 1009 RG & CW: “…is the excess of actual sales over sales at the break-even point.”

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. 63 Break-Even Formula Sales = Fixed Costs + Variable Costs S = $60,000 +.60 S S –.60 S = $60,000.40 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. 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

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