© 2008 by Nelson, a division of Thomson Canada Limited Transparency 9.1 Finance for Non-Financial...

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 9.1

Finance for Non-Financial ManagersFifth Edition

Slides prepared by

Pierre G. BergeronUniversity of Ottawa


Profit Planning and Decision-Making

1. Explain various cost concepts related to break-even analysis such as fixed and variable costs, the relationship between sales revenue and costs, the contribution margin, the relevant range and relevant costs.

2. 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.

3. 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 9: Profit Planning and Decision-Making

Chapter Objectives


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).


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, amortization, telephone


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


The Contribution Margin

PV Ratio

$250,000

$1,000,000

.25

Sales 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


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 amortization)

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


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

Sales revenue ($10.00)

Variable costs ($2.00)

Contribution margin

Fixed costs

Salary

Profit

P.V. Ratio


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


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 sales 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


Break-Even Point By Using the PV Ratio

Step 2: Find the sales revenue break-even point

B.E.P. = = = $600,000

Step 1: Find the PV ratio

PV = = = .333

Fixed costs

PV

$200,000

.333

Contribution

Sales revenue$200,000

$600,000

Finding the break-even point when units are not known, you need to re-structure the P&L statement

$

$

$

$

$

Sales revenue 600,000Variable costs 400,000Contribution margin 200,000

Fixed costs 200,000

Profit/loss 0


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

Sales 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

Sales 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!!!


Cash Break-Even Point

Fixed costs - Amortization

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 - Amortization

PV$150,000

.333


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


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


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


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


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.

© 2008 by Nelson, a division of Thomson Canada Limited Transparency 9.1 Finance for Non-Financial...

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Transcript of © 2008 by Nelson, a division of Thomson Canada Limited Transparency 9.1 Finance for Non-Financial...