Question

SL is faced with a decline in demand due to the downsizing of its major customer. LR, the company's controller, is considering a number of changes which may affect the company's profitability.

Explain how SL's break-even point would change if:
-The selling price per unit decrease.
-Fixed costs increased throughout the entire range of activity.
-Sales people were now compensated on 75% commission and 25% salary and opposed to 75% salary and 25% commission as they were prior.

Answer 1

Break-even point is the volume of sales at which there is no profit or loss. Thus, at break-even point, the contribution (sales – variable costs) is equal to the total fixed costs. The break-even units are calculated by dividing the total fixed costs by the contribution per unit. The break-even dollar sales is calculated by dividing the total fixed costs by the contribution margin percentage (contribution/sales).

If the selling price per unit decreases, the contribution per unit will decrease since there is no change in the per unit variable cost. Thus, the denominator will decrease resulting in a higher break-even point.

With an increase in the fixed costs, the contribution per unit remaining unchanged, the break-even point will increase due to the increased numerator.

With 75% commission and 25% salary to sales people, the variable cost (commission) will increase resulting in a decreased contribution margin ratio, and the fixed cost (salary) will also decrease. Thus, both the numerator (fixed cost) and the denominator (contribution margin ratio) will decrease. The effect of this is explained with an example.

	Old	New
Salary $	100	100
VC	25	75
FC	75	25

	Old	New
Sales $	1000	1000
VC	25	75
Contribution	975	925
FC	75	25
Net income	900	900
CM ratio	97.50%	92.50%
Break-even $	76.92308	27.02703

It is thus seen that the change will result in a decrease in the break-even.