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| | Breakeven Analysis
by MIRA Consulting
The purpose of breakeven analysis is to determine the quantity of output that results in
zero earnings before interest and taxes. This process requires the study of the firm's
cost structure, volume of output, and profit.
A breakeven model can help determine the minimum output necessary to cover all operating
costs as well as predict the earnings before interest and taxes that will be achieved at
various levels.
Benefits of Break Even Analysis
o Capital expenditure analysis
o Pricing policy
o Labor costs
o Firm's cost structure
o Financing decisions
Elements of Break Even Analysis
o Separate production costs into two categories including fixed costs
and variable costs.
Fixed
Costs |
-
Administrative salaries
- Depreciation
- Insurance
- Lump sum expenditures on intermittent costs such as advertising
- Property taxes
- Rent
- Interest charges from debt financing |
Variable
Costs
also known as direct costs |
- Direct labor
- Direct materials
- Energy costs
- Freight costs
- Packaging
- Sales commissions |
Notice: Consult with your
accountant on separating fixed and variable costs.
Development of a breakeven model requires identification of the most relevant output range
for planning purposes because costs do not behave neatly. As such, even fixed costs
can have a semi-variable range. More importantly, however, breakeven analysis
requires appropriate allocation of costs to fixed and variable categories.
A typical method of breakeven analysis is based on volume of output. However, the nature
of operations at some firms are not solely production of test fixtures, nor is it solely
PCB testing. Typically, a breakeven model is based on information obtained from the income
statement.
Sales - (Total variable cost + Total fixed cost) = Profit before interest and taxes
In a manufacturing firm, the breakeven model includes:
P = the sales price per unit
Q= number of units sold
V= variable costs per unit
F= total fixed costs
By setting earnings before interest and taxes (EBIT) to
zero, breakeven analysis may be calculated for a manufacturing company as follows:
P * Q - [ (V * Q) + F ] = EBIT = 0
(P * Q) - (V*Q) - F = $0
Q (P-V) = F
Q = F / (P-V)
When the company is not solely a manufacturing firm and units of production are difficult
and impractical to include in such a calculation as presented above. The reason for this
is that each facilities may have different cost structures.
In a multi-divisional firm, some divisions may generate a high percentage of revenues from
building product while other facilities tend to generate most of its revenues from
services. As such, the firm may be classified as a multiproduct firm. As such, a breakeven
point is more easily calculated in terms of sales.
Sales - (Total variable cost + Total fixed cost) = Profit before interest and taxes.
| Revenue Calculation: S - (VC + F)
= EBIT |
| S |
Sales |
$100,000 |
| VC |
Less: Variable Costs |
- 60,000 |
| R |
Revenue before fixed costs |
= 40,000 |
| F |
Less: Fixed Costs |
- 20,000 |
| E |
Earnings before Interest and Tax (EBIT) |
= 10,000 |
Breakeven Algebraic Expression: S = F / [1 - (VC/S) ]
Using the figures from above and plugging them into the revised algebraic
expression, the
following results are derived to find the breakeven level of sales
denoted by S*:
Example Calculation:
S= $100,000 sales
VC= $ 60,000 variable costs
F= $ 20,000 fixed costs
Therefore:
S* = $ 20,000 / 1 - [60,000/100,000 ]
Breakeven = 50,000
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