Post on 31-Dec-2015
description
Copyright © 2011 Nelson Education Limited
Finance for Non-Financial Managers, 6th edition
PowerPoint Slidesto accompany
Prepared by Pierre Bergeron, University of Ottawa
Copyright © 2011 Nelson Education Limited
Finance for Non-Financial Managers, 6th edition
CHAPTER 5
PROFIT PLANNING AND DECISION-MAKING
Copyright © 2011 Nelson Education Limited
Profit Planning and Decision-Making
1. Explain various cost concepts related to break-even analysis such as fixed and variable costs, the relationship between revenue and costs, the contribution margin, the relevant range and relevant costs.
1. Draw the break-even chart and calculate the break-even point, the cash break-even point and the profit break-even point and how they can be applied in different organizations.
1. Differentiate between different types of cost concepts such as committed and discretionary costs, controllable and non-controllable costs, and direct and indirect costs.
Chapter Reference
Chapter 5: Profit Planning and Decision-Making
Chapter Objectives
Copyright © 2011 Nelson Education Limited
Relevance of Break-Even Analysis
Break-even analysis helps to:
1. Price existing or new products and services.
2. Decide whether to introduce a new product or service,
open a new plant, hire a sales representative, open a new
sales office, launch an advertising program.
3. Modernize or automate an existing plant.
4. Expand an existing plant.
5. Change the cost structure (fixed versus variable).
Copyright © 2011 Nelson Education Limited
1. Fixed and Variable CostsFixed costs
Period costs
Constant costs
Standby costs
Characteristic
Element of fixedness and must be paid with passage of time.
Variable costs
Direct costs
Out-of-pocket costs
Volume costs
Characteristic
Vary almost automatically with volume.
Sales commission, direct labour, packing material, electricity, overtime premiums, equipment rental, truck expenses
Rent, interest, insurance, property taxes, office salaries, depreciation, telephone
Copyright © 2011 Nelson Education Limited
Connection Between Revenue and CostsFactors that affect profit: 1. Volume of production2. Prices3. Costs (fixed and variable)4. Changes in product mix
Cost per Unit
(in $)
16
14
12
10
40 60 80 100
A B
CD
E
G
F
H
% of Capacity
Copyright © 2011 Nelson Education Limited
The Contribution Margin
PV Ratio
$250,000
$1,000,000
.25
Revenue
Less variable costs:
Direct material
Direct labour
Total variable costs
Contribution margin
Less fixed costs:
Manufacturing
Administration
Total fixed costs
Operating profit
($ 500,000)
(250,000)
(150,000)
(50,000)
$ 1,000,000
(750,000)
250,000
(200,000)
$ 50,000PV ratio
Copyright © 2011 Nelson Education Limited
2. J. Smith’s Break-Even (Taxi Driver)
$
Trips6,000
Co
sts
/Rev
enu
e
Variable costs
$2.00
Fixed costs
Insurance
Car payment
(principal or depreciation)
Interest
Dispatcher fees
Variable costs
Gas
Maintenance &
repairs Fixed costs
$15,000
$
$
$
Revenue
Variable costsContribution margin
10.00
2.00
8.00
$
$=
15,000
8.001,875 trips
Revenue$10.00
Total costs
=$
$
45,000
8.005,625 trips
Break-even point
Copyright © 2011 Nelson Education Limited
J. Smith’s Break-Even (Taxi Driver)No salary With salary With salary
1,875
$ 18,750
($ 3,750)
$ 15,000
($ 15,000)
0
0
.80
5,625
$ 56,250
($ 11,250)
$ 45,000
($ 15,000)
($ 30,000)
0
.80
6,000
$ 60,000
($ 12,000)
$ 48,000
($ 15,000)
($ 30,000)
$ 3,000
.80
No. of trips
Revenue ($10.00)
Variable costs ($2.00)
Contribution margin
Fixed costs
Salary
Profit
P.V. Ratio
Copyright © 2011 Nelson Education Limited
Finding the Break-Even Point Using the Formula
Unit selling price $ 15.00 (P)
Fixed costs $200,000 (F)
Unit variable costs $ 10.00 (V)
Break-even calculation
Step 2: $200,000 ÷ $5.00 = 40,000 units (volume)
Step 3: 40,000 units X $15.00 = $600,000 (sales revenue)
Step 1: Contribution margin
Selling price $15.00
Variable costs $10.00
Contribution margin $ 5.00
Copyright © 2011 Nelson Education Limited
Break-Even Point Calculation
Fixed costs
Price per unit sold – Variable cost per unit or unit contribution
$200,000
$15.00 - $10.00
B.E.P. =
In Units
In revenue
B.E.P. = = 40,000 units
Step 2: Find the revenue break-even point
B.E.P. = = = $600,000
Step 1: Find the PV ratio
PV = = = .333
Fixed costs
PV
$200,000
.333
Unit contribution
Unit selling price$5.00
$15.00
X $15.00
$ 600,000
Copyright © 2011 Nelson Education Limited
Break-Even Point By Using the PV Ratio
Step 2: Find the revenue break-even point
B.E.P. = = = $600,000
Step 1: Find the PV ratio
PV = = = .333
Fixed costs
PV
$200,000
.333
Contribution
Revenue$200,000
$600,000
Finding the break-even point when units are not known, you need to re-structure the statement of income
$
$
$
$
$
Revenue 600,000Variable costs 400,000Contribution margin 200,000
Fixed costs 200,000
Profit/loss 0
Copyright © 2011 Nelson Education Limited
Break-Even Point (Retail Store)Suits Jackets Shirts Ties Socks Overcoats Total
No. of units 800 200 700 500 2,500 500
Unit selling price $300 $150 $50 $50 $8 $300
Revenue $500,000
Variable costs
($275,000)
(25,000)
Total variable costs ($300,000)
Contribution margin $200,000
Fixed costs ($100,000)
Profit $100,000
Contribution margin $200,000
Revenue $500,000
Fixed costs $100,000
PV ratio .40
= = .40 or $0.40
= = $250,000
Purchases
Sales commission
(rent, telephone, salaries, security system)
50%
of objective
OK!!!
Copyright © 2011 Nelson Education Limited
Cash Break-Even Point
Fixed costs - Depreciation
Price per unit sold – Variable cost per unit
$ 200,000 - $50,000 $150,000 $15.00 - $10.00 $5.00
In Units
In revenue
= = 30,000 units
= = $450,000
Fixed costs - Depreciation
PV$150,000
.333
Copyright © 2011 Nelson Education Limited
Profit Break-Even
Fixed costs + Profit objective
Price per unit sold – Variable cost per unit
$200,000 + $20,000 $220,000
$15.00 - $10.00 $5.00
In Units
In revenue
= = 44,000 units
= = $660,000
Fixed costs + Profit objective
PV
$220,000
.333
Copyright © 2011 Nelson Education Limited
Sensitivity Analysis
Base case Break-even Break-even
in units in revenue
40,000 $600,000
Selling price
(increased by $0.50 to $15.50) 36,364 $563,642
Change in
Fixed costs
(increased by $50,000 to $250,000) 50,000 $750,000
Variable costs
(decreased by $0.75 to $9.25) 34,782 $521,730
Copyright © 2011 Nelson Education Limited
Company A Company B
Company DCompany C
Revenue
Fixed costs
PV = .40Total costs
Revenue
Fixed costs
PV = .30Total costs
Revenue
Fixed costs
PV = .30
Total costs
Revenue
Fixed costs
PV = .40
Total costs
Break-Even Wedges
Copyright © 2011 Nelson Education Limited
Where Break-Even Analysis Can be Used• Company-wide• Trucking operation• Plant• Direct mail advertising• District or sales territory• Taxi business• Retail store• Movie theatre• Production centre• Advertising program• Department store• Travel agency• Product/division• Hotel business• Service centre• Restaurant business• Machine operation• Book publishing• Airline business
Copyright © 2011 Nelson Education Limited
3. Other Cost Concepts
Committed costs: Costs that must be incurred in order to operate a
business.
Discretionary fixed costs: Costs that can be controlled by managers.
Controllable costs: Costs that operating managers are accountable for.
Non-controllable costs: Costs that are not under the direct control of
managers.
Direct costs: Materials and labour expenses that are directly incurred when
making a product or providing a service.
Indirect costs: Costs that are necessary in the production cycle but that
cannot be clearly allocated to specific products or services.