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The document discusses break even analysis, which is used to determine the sales volume needed for a business to have zero profit. It defines variable costs, fixed costs, unit contribution, and how to calculate break even points. It then provides 5 example calculations of determining break even points and profits for different business scenarios.

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55 views4 pages

Break Even Analysis and Markup

The document discusses break even analysis, which is used to determine the sales volume needed for a business to have zero profit. It defines variable costs, fixed costs, unit contribution, and how to calculate break even points. It then provides 5 example calculations of determining break even points and profits for different business scenarios.

Uploaded by

benaoumeur benouna
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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BSAD 102 – Business Decision-Making

Break Even Analysis and Calculations

I. Break Even Analysis

Determining the break even point for a business, or a specific proposed investment (project) within
a business, can be a useful business planning tool. The break even point may be thought of as the
point at which net profit equals zero.

Calculating break even is also referred to as cost-volume-profit analysis, contribution analysis or


sensitivity analysis. Break even analysis is sometimes referred to as cost-volume-profit analysis
because these are three key elements (i.e. cost, volume and profit) in the calculation. It is
sometimes referred to as contribution analysis because calculating break even requires
determining how many service or product contributions (selling price per unit minus variable costs
per unit) are necessary to cover, or pay for, the product's or project's expected fixed costs. It is
sometimes referred to as sensitivity analysis because changing one of the input variables allows us
to see what difference the change makes to break even volume, etc.

The break even point occurs when sales (revenue) equals expenses or costs. Costs are either
variable or fixed. Variable costs tend to vary directly with the number of units made or sold.
Examples include ingredients and packaging, sometimes labour (piece rate work), sometimes
transportation and sometimes sales commissions. Fixed costs tend to be relatively constant no
matter how many units are made or sold. Examples include rent, management salaries and
advertising.

Unit contribution is the amount of money remaining after the variable costs of producing or
purchasing one unit is subtracted from the selling price of one unit:

Selling price per unit – Variable costs per unit = Unit contribution

Total contribution is determined by multiplying unit contribution times the number of units sold.

Unit contribution x Number of units sold = Total contribution

A break even calculation example. A store sells t-shirts. The average selling price is $15 and the
average variable cost (cost price) is $9. Thus, every time the store sells a shirt it has $6
remaining after it pays the manufacturer. This $6 is referred to as the unit contribution. The
word contribution is appropriate since the $6 contributes to cover fixed costs and, once the fixed
costs are covered, the $6 contributes to profit. Suppose the fixed costs of operating the store (its
operating expenses) are $100,000 per year. The question then becomes how many contributions
of $6 are necessary to cover all fixed costs. The calculation is:
2

Total Fixed Costs


Break even Point =
(in units) Selling price/ – Variable costs/
unit unit

Total Fixed Costs


=
Unit Contribution

$100,000
=
$15 – $9

$100,000
=
$6

= 16,667 units (tee shirts)

Thus, the store has to sell 16,667 t-shirts to reach break even. Changing any of the fixed costs, the
average selling price per t-shirt or the average variable cost per t-shirt (sensitivity analysis) would
change the break even point. For example:

• if fixed costs rose to $110,000, break even volume would rise to 18,333 shirts ($110,000
÷ $6) or
• if the average selling price rose to $16, break even volume would fall to 14,286 shirts
($100,000 ÷ $7) or
• if the variable cost of purchasing the tee shirts rose to $10, break even volume would
rise to 20,000 shirts ($100,000 ÷ $5).

If the owner/manager desired a profit of $25,000, this would be added to the store's anticipated fixed
costs of $100,000 to determine the number of t-shirts (volume) necessary not only to break even but
to make a profit of $25,000. In this instance the volume would rise to 20,833 t-shirts ($125,000 ÷
$6). When a desired profit is added on, the calculation ceases to be ‘break even’ and becomes
Target Sales (in units)

Total Fixed Costs + Target Profit


Target Sales =
(in units) Selling price/ – Variable costs/
unit unit
3

II. Break Even Calculations

1. A small publisher selling to book distributors has fixed operating costs of $600,000 each year
and variable costs of $3.00 per book. How many books must the firm sell to break even if the
selling price is $6.00?

2. Novelties Ltd. produces miniature Canadian flag decals. The fixed costs for their latest project
are $5,000. The variable costs are $0.70 per flag and the company should be able to sell them
for $2.00 each. How many flags must Novelties Ltd. sell to break even? How many flags must
the company sell to make a profit of $2,000? If the maximum number of flags the company can
sell is 5000, should it get involved in this project?

3. Jennifer buys roses for $1.00 each and sells them in the waterfront and downtown areas of
Halifax for $2.00 each. Each summer her fixed costs are about $500.
(a) What is her break even point?
b (b) In 2001 she sold 4,000 roses. How much profit did she make?

4. A new venture creation team at the local university intends to make and sell large, heart-shaped
personalized (red and white icing and lettering) Valentines Day sugar cookies. Initial estimates
are:

Ingredients ………………….. $ .18 per cookie Advertising ………… $500.00


Labour to bake the cookies….. .11 per cookie Booth space rental .. 150.00
Packaging …………………… .07 per cookie Selling (wages) …… 300.00
Labour to personalize messages .10 per cookie Est. market potential .. 2,500 cookies

The team plans to employ the slogan, and pricing scheme, "A Loonie for Love." Calculate the
unit contribution, and the break even point. Indicate the share of market potential necessary to
break even and draw a tentative conclusion about proceeding with this venture. Do you have
any suggestions for altering the strategy to be more profitable?

5. New Tech Corporation has completed development of a new electronic toy. It expects to sell
15,000 units in the first year and 25,000 units in the second year. The following financial data
has been assembled.

Wholesale selling price................................................... $ 35.00


Material cost/unit............................................................ $ 5.00
Labor cost/unit................................................................ $ 6.50
Packaging cost/unit......................................................... $ .50
Sales force salaries and expenses.................................... $150,000
Manufacturing overhead................................................. $ 75,000
Administrative expenses................................................. $ 70,000
Sales promotion (first year only)..................................... $ 40,000
4

Prepare a two-year financial summary for the new toy, including: variable cost per unit,
contribution per unit, total contribution, total fixed costs, break-even volume, gross margin, and
net profit. Prepare pro forma income statements for years 1 and 2 and determine the net
income for each of those years.

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