THE BREAK EVEN POINT AND RELATIVE TOPICS



WHAT IS A BREAK EVEN POINT

   this is a situation of a profit and loss statement where there is no profit  or  even loss, that means the SALES AMOUNT is equal to the total cost  both  fixed cost and variable cost  hence no profit nor loss.

  example:

                 SALES                                  500.00
                 VARIABLE COST     300.00
                 FIXED COST            200.00
                   NET PROFIT                          0     

It may also answer to the question as to how many units of products must be sold so the company may operate to produce income.

What is variable cost. -   basically this is a cost or expenses  that tends to increase , if the volume of sale s or the amount of sales increase   or  that tends to decrease if the volume of sales decreases.


   EXAMPLE :
1.    in a trading concern,  the cost of the product sold
2.   the  sales discount ,  salesmans commision ,  sales taxes, sales promotion expenses, freight cost, etc.etc.

What is fixed cost    -    basically these expenses which will not  increase nor decrease even the sales volume increases or even decreases , that is why it is called FIXED COST.
  example:

         office salaries,  depreciation exp,  communications exp, and  administrative expenses.

Assuming the company sells a single product

           SELLING PRICE                          20.00     100%
           VARIABLE COST                        12..00       60%
          =CONTRIBUTION MARGIN         8.00        40%

that means whatever volume of sales the company registers,  its  variable cost ratio will be  basically always 60% and the contribution margin will always be 40%.  THE  PERCENTAGE RATIO IS BASICALLY THE ONE WHICH IS FIXED.

In the case of fixed cost  irrespective of the volume of sales the corresponding fixed cost will not changed, therefore fixed cost ratio is the one that  will  CHANGE.

That means to compute for the break even  sales,  contribution margin must be the same amount as that of the FIXED COST.,  SO,  the fixed cost ratio should be assumed as the same with the ratio of the conttribution margin ratio.

EXAMPLE:   IF THE CONTRIBUTION MARGIN IS  40%, AND THE FIXED COST AMOUNT BEING EXPERIENCED BY THE COMPANY IS  50,000.00 ,  it should be presumed that the 50,000 has also 40% ratio against  sales same as that of the contribution margin . SO THAT if you divide that fixed cost to its copied ratio from the CONTRIBUTION MARGIN ratio you will get the SALES AMOUNT TO HAVE A BREAK EVEN SALES/      TO WIT


                            50,000  DIVIDE 40%  =   125,000  SALES AMOUNT TO HAVE A CONTRIBUTION MARGIN OF 50,000 , WHICH IS THE SAME WITH THE FIXED COST.

               SALES BREAK EVEN  125,000        100%
              VARIABLE COST          75,000            60%
  CONTRIBUTION MARGIN      50,000         40%
LESS FIXED COST                      50,000         40%
NET PROFIT                                  0

ANY AMOUNT IF YOU DIVIDE IT BY ITS RATIO, YOU WILL GET THE 100% . THAT IS WHY DIVIDING 50,000 BY 40% YOU GET  THE 100% WHICH IS SALES.

TAKE NOTE THAT IF THE VARIABLE COST AMOUNT IS NOT GIVEN,  SIMPLY USE ITS GIVEN  RATIO THEN MULTIPLY TO SALES TO GET ITS CORRESPONDING AMOUNT.   THE SAME IS TRUE WITH THE CONTRIBUTION MARGIN.

IF IN CASE , THE QUANTITY OF SALES TO BREAK EVEN IS DESIRED TO BE KNOWN THEN THE FORMULA IS .

                   FIXED COST DIVIDE  CONTRIBUTION MARGIN PER UNIT = QTY OF SALES TO BREAK EVEN.

EXAMPLE        50,000 DIVIDE 8.00 =   6,250 UNITS X 20.00   = 125,000.00

                  OR  50,000 DIVIDE 40% = 125,000 DIVIDE  20.00  =6,250 UNITS.

REPEAT,  TO HAVE A BREAK SALES,  FIXED COST MUST BE EQUAL WITH THE CONTRIBUTION MARGIN. THAT MEANS IN A  BREAK EVEN SITUATION,  FIXED COST RATIO IS ALSO THE SAME RATIO WITH THAT  OF THE CONTRIBUTION MARGIN.

SO IF THE FIXED COST IS GIVEN AND THE CONTRIBUTION MARGIN IS GIVEN, YOU CAN COMPUTE FOR THE BREAK EVEN SALES  AS EXPLAINED ABOVE.

 IN the above example,  where 6,250 is the break even sales quantity,  any quantity in excess of 6,250 multiplied by the contribution margin per unit is automatically the net profit.

If what is given is the fixed cost amount and the variable cost per unit of product, dividing that fixed cost amount with that of the variable cost per unit will result to the SALES QUANTITY to bread even.


THIS CONCEPT OF BREAK EVEN POINT CAN BE EXPOUNDED SO THAT A SALES REVENUE CAN BE COMPUTED SO THAT  A  DESIRED PROFIT CAN BE ATTAINED.

THESE QUESTIONS:

        1.  HOW MUCH SALES VOLUME OR QUANTITY SO THAT A DESIRED PROFIT AMOUNT OR PROFIT RATIO BE ATTAINED.
      2.   HOW MUCH FIXED COST AMOUNT  MUST A COMPANY INCUR SO THAT A CERTAIN PROFIT BE ATTAINED.
   3.  HOW MUCH FIXED MUST BE REDUCED SO THAT  A  DESIRED PROFIT AMOUNT OR RATIO BE ATTAINED.
4.  WHAT WOULD BE THE EFFECT TO THE PROFIT  IF THE VARIABLE COST WOULD INCREASE OR DECREASE.


EXAMPLE.   WHAT VOLUME OF SALES IS NEEDED SO THAT A DESIRED PROFIT AMOUNT BE ACHIEVED.

      1.  CONTRIBUTION MARGIN IS 30%
      2.  FIXED COST IS  400,000
      3.  THE COMPANY WANTS TO ATTAINED A  200,000 PROFIT

 THE FORMULA IS :        SUM OF FIXED COST AND PROFIT DIVIDE  CONTRIBUTION MARGIN.

   SO,       600,000  DIVIDE 70%  =  857,142.00 SALES AMOUNT

TO PROVE:
                     SALES                            857,142
                LESS variable cost                257,142     30% x 2.0M
               contribution margin                 600,000      70%
             less fixed cost                           400,000     46.66%
               profit                                      200,000     23.34%


EXPLANATION:

the contribution margin will always be the amount that would cover the fixed cost and the profit. IF THIS IS THE CASE,  THE TOTAL FIXED COST AMOUNT PLUS THE PROFIT DESIRED AMOUNT IS PRESUMED HAVE THE SAME  PERCENTAGE RATIO WITH THAT OF THE CONTRIBUTION MARGIN  BECAUSE   THE TOTAL FIXED COST PLUS THE PROFIT IS EQUAL TO THE CONTRIBUTION MARGIN .

AND SINCE IF YOU DIVIDE  THE TOTAL OF FIXED COST AND PROFIT WITH THE PERCENTAGE RATIO OF CONTRIBUTION MARGIN ,YOU WILL ARRIVE TO THE 100% WHICH IS SALES AMOUNT.

NOW , ANOTHER THING , THE PROBLEM MAY BE  ASKED IF SUPPOSING THE COMPANY WANTS TO KNOW THE SALES TO  BE ATTAINED SO THAT THE NET PROFIT AFTER TAX IS ACHIEVED.

EXAMPLE.

THE FIXED COST IS  400,000 AND THE DESIRED PROFIT AFTER TAX IS 60,000 AND THE TAX RATE BASED ON NET INCOME BEFORE TAX IS 40%.   COMPUTE  HOW MUCH SALES IS NEEDED TO HAVE A 60,000  PROFIT.

LET ME SHOW YOU THE  PROFORMA  PROFIT AND LOSS

   SALES                                              ?
    VARIABLE COST                           ?
CONTRIBUTION MARGIN              ?         30%
FIXED COST                              400,000
  NET PROFIT BEFORE TAX                     100%
 INCOME TAX                                             40%
 NET INCOME                            60,000    

Let me first explain the above  format .

As I have always said, any amount if divided by its representative percentage you will arrive at its base amount which is 100%. In the above date no amount is represented by percentage, however we know that the net profit before tax is the one subject to 40%, that means this profit is the 100% where this 40% will be multiplied. Therefore deducting 40% tax rate with the 100% tax base you will get 60% as the net income after tax..

now since we have the equivalent ratio of 60,000 of 60% , dividing 60,000 by 60% you will get 100,000 as the net income subject to tax.  .

the answer is  100,000 as the net income before tax, now, since this 100,000 is arrived after deducting the fixed cost of  400,000 , therefore the contribution margin is 500,000  which has a percentage ratio to sales of 30%, now dividing the 500,000 by 30%  you will get the sales base where this 30% was applied or the sales amount needed is 1,666,666 to attain a profit after tax of 60,000.

      THE FORMULA CAN BE USED IS AS  FF:

               NET INCOME AFTER TAX
_________________________________   +  fixed cost divide contribution margin rati0 = SALES
                      100-  TAX rate                                           


                       60,000
                     ______     ___   100,000 + 400,000 divide 30% =  1,666,666
                      60%


to prove:

 SALES                                         1,666,666
 VARIABLE COST                        1,166,666
CONTRIBUTION MARGIN           500,000
FIXED COST                                   400,000
NET PROFIT                                    100,000
TAX  40% X100,000                          40,000
NET PROFIT AFTER TAX                60,000
             
  WHAT OTHER ISSUES  CAN BE DEDUCED FROM THE BREAK EVEN ISSUE.

1.  IF  A CERTAIN ITEM OF VARIABLE EXPENSES WILL INCREASE OR DECREASE  AS A NOT AS A RESULT OF DECREASE  OR INCREASE SALES BUT BECAUSE OF THE INCREASE OR DECREASE OF ITS PURCHASE COST.  WHAT WOULD BE THE SALES TO MAINTAIN THE SAME PROFITABILITY.                   

2.  THE COMPANY MEASURES IS PROFITABILITY IN TERMS OF RATIO TO SALES AND NOT IN TERMS OF AMOUNT , WHAT WOULD BE THE FORMULA TO COMPUTE SUCH SALES.

3.  IF A CERTAIN ITEM OF FIXED EXPENSES WILL INCREASE OR DECREASE, WHAT IS THE EFFECT ON PROFIT OR WHAT SALES AMOUNT MUST BE ATTAIN TO MAINTAIN THE SAME PROFITABILITY.