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Smith, Conley & Associates, PC
Business Development Update
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Contents
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Quote
Of The Month
Financial Concept- Break even analysis
Feature Article- How
to calculate Break even points
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Quote of the
Month
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The
Wealthy person has just "won life's lottery" -
Congressman Dick Gephart
Sorry Dick, but we believe hard work, wise choices, treating
customers
right, (and good tax advice) make for financial success !
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Concept
for this
week
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What you
can measure, you can manage. Therefore, how do we
measure where we want to
be?
Most clients don't understand what a powerful measure tool
breakeven
analysis can be. Read carefully and e mail us with
your questions.
Break-even analysis can be a very useful and relatively
simple tool
for management to use in making decisions. It
can be used for dealing with
unknown variables such as
demand. By specifying the levels of known
variables such
as cost or profit a required or minimum level can be found
for the unknown variable. Any problem requiring income
estimation can be
set up so that the most difficult
variable to estimate is isolated for
solution.
Look at the ways in which break-even
analysis can be applied
to sales, profits, and costs. It
also illustrates how it can be used to help
make sound
decisions for your business such as employing idle plant
capacity, planning advertising, granting credit, and
expanding
production. Break-even analysis is not a
universal remedy. It is only one of
the many tools
available to the business decision maker.
The Starting Point: Calculating Break-Even
Before you can decide upon
a fair price for your product,
you need to know how much it's costing you!
You'll need to
know this no matter which pricing method you use.
Once
you've identified costs, you can determine your break-
even point. This is
the point at which you neither make
nor lose money in producing a product or
delivering a
service. For example, you would be at the break-even point
if it cost you $100 to produce a product that you sell for
$100.
A
break-even analysis is the process you use to uncover
those break-even
numbers. To begin your break-even
analysis, add up all fixed costs and
determine what your
variable costs are at different production volumes.
Fixed costs, sometimes referred to as overhead, are
expenses that don't
vary according to production amounts
such as rent for office space (and
storage space if you
store inventory), office equipment (telephones, faxes,
computers, etc.), insurance, utilities, etc.
Variable costs are expenses
that do vary with the amount
of service provided or goods produced. They
include costs
such as hourly pay for a contractor on a specific project,
raw materials, etc. Some variable costs don't depend
specifically on the
number of products produced but are
still variable, such as advertising or
promotion expenses.
You must know the cost of your overhead (fixed costs) as
well as the incremental cost-per-unit (variable costs)
before you can
determine your break-even points.
Next, substitute your figures into the
following break-
even formulas. See our lead article for example.
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Lead Article
How to Calculate Break even
points
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Operational
Terms
Fixed Costs are those costs that are not variable as a
result of the
sales activity. For example, rent of the
building or insurance costs may be
fairly constant no
matter how sales vary, while, expenses such as
advertising
and usage of shop or store supplies will vary with
sales.
Contribution Margin = (Revenue - Variable Costs) /
Revenue. In a retail
business, the gross margin % is
generally recognized as the Contribution
Margin %. Gross
Margin equals the difference between the Sales and the
Cost of the Sales. In this example, $1,667,667 are the
sales that are
required to cover fixed costs of $250,000
and a margin of 15%, with nothing
left over for profit
For example, you calculated that your sunglasses
manufacturing plant has
fixed overhead expenses of $7,000
a year. That covers items such as the
rent, electric bill
and payroll. To make, advertise and mail the sunglasses
costs $4.50 a pair. That is your variable cost. You think
you can easily
sell the sunglasses for $12 each, based on
your industry research.
So: $7,000 divided by ($12 minus $4.50) = 933
You would have to sell 933 pairs of sunglasses to break
even.
In
dollars, you can calculate the sales volume needed to
reach the break-even
point by multiplying the number of
sunglasses you need to sell by the
selling price: 933 x
$12 = $11,196
Break-even analysis can show you profit levels of sales
and help you
determine the success of your project before
you start. However, it does not
help you to examine cash
flow, the actual movement of cash in and out of
business.
Getting a handle on cash flow is essential to maintaining
financial control.
Let us know if you have need for additional tools in this area such as excel worksheets,etc. Our excel sheets will permit you to run breakeven levels by number of units, hours worked, or even calculate the effects of changing the price AND the volume with just two clicks of the mouse.
SCA
© Copyright 2001 Smith, Conley & Associates
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