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����������� ���Break-Even ���
��������������������������������� ���������������������� �����������!����
Presented by Steve LeFever, Chairman
Profit Mastery
Business Resource Services Inc. 200 First Avenue West �� Suite 301 � Seattle, Washington 98119 Phone 206-284-5102 � [email protected] � www.profitmastery.net
Assets = Liabilities + Net WorthSales
Balance Sheet
Efficiency
Income Statement
� To pay for new assets� To pay off debt� To pay out to the owners
Net Profit
Uses of Profits:
Net Profits Cash Flow
What�Gets�Measured...Gets�Managed�
���������Profit�Mastery®
Financial�Performance�is�a�three�legged�stool�
� Education�–�establishing�the�foundation
� Benchmarking�–�creating�the�yardstick
� Performance�Groups�–�providing�theaccountability�and�discipline
Financial�Operating�Cycle�
©2015 BRS 1
Seven�Steps�to�Business�Success�
1. Plan�properly�before�start�up
2. Monitor�financial�position
3. Understand�the�relationship�betweenprice,�volume,�and�costs�
4. Manage�cash�flow
5. Manage�growth
6. Borrow�properly
7. Plan�for�transition
©2015 BRS 2
Income�Statement�ManagementKnowing�Your�Costs�
DEFINITION�..........�Managing�the�income�statement�implies��managing��the�relationship�between�costs,�volume�and�pricing.��Break�even�analysis�is�the�tool�that�lets�owners��and��managers�gauge�the�results�of�changes�in�costs�or�pricing.�
REVIEW�...............�We�have�completed�the�section�on�financial�statement�analysis,�which�gives�us�a�picture�of�the�past.��With�break�even�analysis,�we�have�a�method�to�analyze�the�present.�
IMPACT�...............�Break�even�analysis�focuses�attention�on�two�kinds�of�costs����fixed�costs�and�variable�costs����and�how�changes�in�either�affect�profits.��The�analysis�answers�questions�such�as:��“Will�a�decrease�in�price�produce�more�sales?”�
RESULTS�..............�Using�the�break�even�tool,�we�will�be�able�to�relate�changes�in�costs�and/or�changes�in�pricing�to�the�corresponding�changes�that�are�required�in�sales�volume�if�a�given�level�of�profit�is�to�be�maintained.�
The�Goal:�
Calculating�the�sales�required�to�incur�no�profit,�but�no�loss�""�and�to�evaluate�the�impact�of�changes�in�costs�on�
the�selling�price"cost"volume�relationship.�
The�Tools:�
Break���Even��Analysis�Break���Even��Proofs�Expansion��Analysis�
©2015 BRS 3
Key�Terms
Break"Even�....................................... To�have�no�profit�and�no�loss;�the�point�at�which�revenues�exactly�cover�expenses.�
Variable�Costs�.................................. Expenses�that�vary�directly�with�sales;�those�costs�that�are�incurred�only�if�sales�are�made.�
Variable�Cost�Percentage�................ The�percent�of�each�dollar�of�sales�that�goes�to�cover�variable�costs.�
Fixed�Costs�....................................... Expenses�that�do�not�vary�with�sales;�those�costs�that�are�incurred�whether�or�not�any�sales�are�made.�
Contribution�Margin�........................ The�amount�left�after�variable�costs�are�paid.����The�amount�that�is�left�to�contribute�to�covering�fixed�costs�(and�profits).�
Contribution�Margin�Percentage�.... The�percent�of�each�dollar�of�sales�that�is�left�after�the�variable�cost�percentage�has�been�deducted;�the�amount�from�each�dollar�of�sales�that�is�contributed�to�cover�fixed�costs�and�profits.�
Target�Profit�..................................... The�amount�of�profit�that�is�planned.��The�profit�that�is�added�to�fixed�costs�to�determine�the�sales�goals����in�relation�to�a�given�contribution�margin.�
©2015 BRS 4
Break"Even���(as�explained�by�your�college�professor)�
Costs�
Sales�
Break"Even�4"Step�Process�
1. Classify�expenses�as�variable�or�fixed
2. Determine�Variable�Cost�Percentage
3. Determine�Contribution�Margin�Percentage
4. Calculate�Break�Even�in�dollars
©2015 BRS 5
How�Do�Fixed�Costs�Behave?�
How�Do�Variable�Costs�Behave?�
©2015 BRS 6
Understanding�Contribution�Margin�
���
��������
With�Net�Profit�at�0,�you�are�at�Break"Even�
What�Types�of�Questions��Can�Break"Even�Answer?�
1. If�I�cut�or�add�a�fixed�cost�how�will�it�impact�the��volumeof�sales�I�need�to�Break�Even?
2. If�I�lower�prices�how�will�it�impact�Break�Even?
3. If�I�raise�prices�how�will�it�impact�Break�Even?
Sales�- COGS�- Gross�Profit�- OE�
Net�Profit�
Sales��V�C�What’s�Left���F�C�Net�Profit�
Contribution�Margin�
©2015 BRS 7
Steve’s�Pen�Company�
©2015 BRS 8
Sales
VariableCostCup
FixedCostCup
NetProfitCup
Contribution Margin
The�Cup�Theory��The�Concept�of�Contribution�Margin�
©2015 BRS 9
Target�a�Profit�
You�want�to�have�a�profit�of�$200,000�at�the�end�of�the�fiscal�year.���
What�do�you�need�in�increased�sales�to�insure�this�level�of�profit?�
Fixed�Costs�=�$800,000�(FC)�
Targeted�Profits�=�$200,000�(TP)�
Total�FC�+�TP�=�$1,000,000�
©2015 BRS 10
Sales
VariableCostCup
FixedCostCup
NetProfitCup
Contribution Margin
Four�Ways�to�Increase�Profits�
�
1.���
2.���
3.���
4.���
What’s�the�strategic�management�value�of�this�picture?�
©2015 BRS 11
Break"even�Case�Study�"�Dollars�Lake’s�Pharmacy�Practice�Example�
Two�years�ago�Brad�and�René�wanted�to�figure�their�break�even�sales�volume,�so�they�went�through�their�most�recent�income�statement�and�classified�and�totaled�each�category.��Here's�what�they�got:�
Variable�Cost:�..................�$1,275,000�
Fixed�Cost:�..........................�$357,000�
His�Sales�were:�
Sales�................................�$1,700,000�
1. What�were�break�even�sales�for�Lake’s?��Use�your�break�even�worksheet�to�do�thecalculations.
©2015 BRS 12
Break"even�Case�Study�"�Dollars�Lake’s�Pharmacy�
You�have�been�called�in�to�provide�some�assistance�to�Lake’s.��They�have�already�gone�through�their�most�recent�income�statement�and�classified�costs�into�fixed�and�variable.��Here�is�what�they�came�up�with:�
Variable�Cost:�..................�$1,986,700�
Fixed�Cost:�..........................�$490,800�
Lake’s�sales�were:�
Sales�................................�$2,500,000�
Your�job�now�is�to�calculate�their�variable�cost�percentage,�their�contribution�margin,�and�his�break�even�sales�point;�then�answer�the�questions�below.��(Remember:�Lake’s�made�a�profit�in�that�year����they�were�not�at�break�even�sales�last�year.)�
1. What�are�break�even�sales�for�Lake’s�Pharmacy?
2. What�additional�annual�sales�are�needed�if�rent�increases�by�$2,000/month?
©2015 BRS 13
Break"even�Case�Study�"�Dollars�Lake’s�Pharmacy�
�. ��������� � ��������� �������������������� �������������������� �� ��!��"��������������� ���������������� ##������%����������&���������*
-. "���������������������� ���������� ������<���������&������������ ��������������� ��� ���*
©2015 BRS 14
Break"even�Case�Study�"�Units�Lake’s�Pharmacy�
Lake’s�has�a�homogeneous�unit����prescriptions����that�can�be�used�to�measure�all�product�sold.��What�René�and�Brad�need�to�know�now�are�how�many�prescriptions�they�need�to�sell.��Here�is�the�cost�breakdown�per�prescription:�
Sales�Price�(per�prescriptions)�..........�$56.80/�prescriptions�
Variable�Cost�(per�prescriptions)�......�$43.50/�prescriptions�
Fixed�Cost��...................................................�$490,800�
1. How�many�prescriptions�must�be�sold�to�break�even?
2. How�many�prescriptions�must�be�sold�by�a�new�Pharmacist�(who�will�get�an�annualsalary�of�$95,000)�to�cover�their�cost?
3. How�many�prescriptions�must�be�sold�if�the�selling�price�is�raised�to�$57.63�perprescription����assuming�there�is�no�new�salesperson�and�no�change�in�variablecost?
What�if�price�decreases�to�$55.37?�
©2015 BRS 15
�
Expansion�Case�Lake’s�Pharmacy�
The�Profit�Mastery®�process�and�tools�combined�with�René�and�Brad‘s�marketing�skills�have�them�contemplating�another�store.��This�store�will�be�located�in�an�area�similar�to�the�current�location,�and�where�they�have�noticed�that�the�competition�is�weak.��So�they�pulled�together�the�following�information�to�help�him�make�the�decision:���
�� Expected�Variable�Cost�Percentage..................76%��� Expected�Fixed�Costs.....................................$350,000��� Investment�in�Current�and�Fixed�Assets...........$400,000��� Minimum�return�on�investment.......................20%��
�1. What�total�sales�are�necessary�to�cover�their�fixed�costs�and�minimum�ROI?�(Follow�
these�steps)��� a.�Investment�x�minimum�ROI�=�profit�required�to�achieve�ROI����� b.�Fixed�costs�+�ROI�=�Total�cost�to�be�covered����� c.�100%���variable�cost�%�=�Contribution�Margin������ d.�Total�Cost/�CM%�=�Sales�Target����
2. How�many�customers�must�Lake’s�attract�to�the�new�store�to�break�even?�(Use�your�store’s�average�dollars�purchased�per�customer).�
�
©2015 BRS 16
Break"Even�Analysis�Break�even�analysis�identifies�that�point�where�revenues�exactly�cover�costs����so�that�no�profit�is�generated,�but�no�loss�is�incurred.��As�a�management�tool,�it�extends�to�a�much�broader�application.��Using�it,�you�can�answer�questions�such�as:
�WhatadditionalsaleswillIneedtocovertherentincreasemylandlordisproposing?
�IfIraiseprices,howmuchcanmysalesdropbeforemyprofitsareaffected?
�Ifsalesdrop(inarecession,forexample),howmuchdoIneedtocutfixedcoststomaintainmycurrentlevelofprofit?
�IfIcutmyprice,whatadditionalsaleswillIhavetomakeinordertomaintainmycurrentprofitlevel?
Steps�to�Calculate�Break"Even�
Step�1�
Classify�expenses�from�your�current�income�statement�into�two�cost�categories:��fixed�or�variable.��Then�add�up�the�total�for�each�category.�
Fixed�Costs����are�those�that�remain�constant�over�a�reasonable�range�of�sales,�or�do�not�vary�appreciably�with�sales�volume.��For�example:�
� Rent � Office�Supplies � Advertising
� Salaries � Payroll�Taxes � Utilities
� Depreciation � Interest�Expense � Insurance
When�these�do�change,�they�tend�to�jump�in�increments����such�as�rent�increases�for�additional�space,�depreciation�on�new�equipment�purchases,�or�salaries�for�additional�staff.��When�this�type�of�increase�occurs,�break�even�needs�to�be�recalculated.�
Variable�Costs����are�those�that�vary�directly����or�proportionally����to�sales.��An�easy�way�to�evaluate�whether�a�cost�is�fixed�or�variable�is�to�ask:��do�sales�cause�this�cost?��If�sales�cause�the�cost,�it's�variable.��For�example:�
� Direct�Labor � Commissions
� Direct�Materials � Bad�Debts
If�you�can't�decide�what�to�call�an�expense,�be�conservative�and�call�it�fixed����thus�making�your�break�even�point�higher.�
©2015 BRS 17
Step�2�Determine�the�variable�expense�percentage����that�is,�the�total�variable�expense�as�a�percentage�of�sales:�
VARIABLE��COSTS��=��VARIABLE��COST��PERCENTAGE�SALES�
Step�3�Determine�the�contribution�margin����that�is,�the�amount�from�each�sales�dollar�which�is�left�after�deducting�variable�costs����to�cover�fixed�costs:�
SALES�%��–��VARIABLE�COST�%��=��CONTRIBUTION�MARGIN�%�
Which�is�the�same�thing�as:�
100%��–��VARIABLE�COST�%��=��CONTRIBUTION�MARGIN�%�
Step�4�Calculate�break�even�using�one�of�the�two�following�formulas:�
To�calculate�break�even�in�dollars:�
BREAK–EVEN��=�������������FIXED�COSTS�������CONTRIBUTION�MARGIN%�
NOTE:��Express�contribution�margin�as�a�decimal�""�not�a�percentage.�
To�calculate�break�even�in�units�(ifyourproductcanbemeasuredinjustonetypeofunitsuchasyards,gallons,cases,orhours):�
BREAK–EVEN��=��������������FIXED�COSTS��SELLING� VARIABLE�
PRICE� –COSTPER�UNIT� PER�UNIT�
©2015 BRS 18
Cost�–�Volume�–�Profit�Relationships�Break�Even�Analysis:�Dollar�Basis�
Step�1�""�Classify�Your�Costs�
Using�your�most�recent�income�statements,�classify�all�costs�as�either�fixed�or�variable,�then�total�each�category.�Actual�Total�Sales� =��$_______________�
Total�Variable�Costs� =��$_______________�
Total�Fixed�Costs� =��$_______________�
Step�2�""�Calculate�Variable�Cost�Percent�
“Forevery$1.00ofsales,whatpercentgoesawaytovariablecosts.”�
Variable�Cost�Percentage��=��Total�Variable�Costs���=� $_______________��=��_____%�Actual�Total�Sales� $�
Step�3�""�Calculate�Contribution�Margin�
“Forevery$1.00ofsales(afterpayingforvariablecosts),whatpercentislefttocoverfixedcosts...plusanytargetedprofit?”�
100%�–�Variable�Cost�Percentage��=��100%��–��_____%��=��_____%�
Step�4�""�Calculate�Break"Even�Sales�
“Howmany‘centses’doesittaketocoveryourfixedcosts?”�
Break�Even�Sales��=���Total�Fixed�Costs����=��$_______________��=��$_______________��Contribution�Margin�%������������������������������%�
NOTE:��Tocalculatethesalesneededtogenerateatargetprofit,justaddthattargetprofitamounttoyour totalfixedcosts,thendividethatamountbyyourcontributionmargin.
Step�5�""�Check�Your�Calculations�
“Doesthesaleslevelyoufiguredactually‘breakeven’orgiveyoutheprofitsyoutarget?”�� � Break�Even�Sales� � _______________�
minus� Variable�Costs�*� – _______________
equals� Contribution�Dollars� =� _______________�
minus� Fixed�Costs� – _______________
equals� Net�Profit� =� _______________�
* ComputethisfigurebymultiplyingBreakEven(above)bytheVariableCostPercentinStep2.
©2015 BRS 19
Cost�–�Volume�–�Profit�Relationships�Break�Even�Analysis:�Unit�Basis
Step�1�""�Classify�Your�Costs�
Using�your�most�recent�income�statements,�classify�all�costs�as�either�fixed�or�variable,�then�total�each�category.��Record�the�actual�number�of�units�sold�and�actual�sales�volume.�
Actual�Total�Sales� =��$_______________�
Total�Variable�Costs� =��$_______________�
Total�Fixed�Costs� =��$_______________�
Total�Units�Sold� =��________________�
Step�2�""�Calculate�Your�Price�Per�unit�
Price�Per�Unit��=�����������Total�Sales�����������=��$_______________�per�unit�Number�of�Units�Sold�
Step�3�""�Calculate�Your�Variable�Cost�Per�Unit�
Variable�Cost�Per�Unit��=��Total�Variable�Costs��=��$_______________�per�unit�Total�Units�Sold�
Step�4�""�Calculate�Your�Contribution�Dollars�Per�Unit�
Price�per�Unit��–��Variable�Cost�per�Unit�
=��$___________per�unit��–��$_________�per�unit��=��$_____________�per�unit�
Step�5�""�Calculate�Your�Break"Even�Sales�in�Units�
Break�Even�Sales��=����������Total�Fixed�Costs��������Contribution�Dollars�per�Unit�
=� $_______________� =� __________�units�needed�in�sales�to�“break�even”�$�������������������per�unit�
NOTE:� Tocalculatethesalesneededtogenerateatargetprofit,justaddthattargetprofitamounttoyourtotalfixedcosts,thendividethatamountbyyourcontributionmargin.
©2015 BRS 20