Question

BREAK-EVEN ANALYSIS EXERCISE

Break-even analysis attempts to determine the volume of sales necessary for a business to cover costs, or to make revenue equal costs. It is helpful in setting prices, estimating profit or loss potentials, and planning for the coming period.

The general formula for calculating break-even units is:

Break-even Units = Fixed Costs / Price – Unit Variable Cost

1. An important distinction is made in the calculation between fixed and variable costs. Fixed costs do not change with the units sold (at least in the short term). Variable costs depend on the units sold in the period. Identify each of the following as a fixed (F) or variable (V) cost in the context of BizCafe:

	F or V
Coffee
Advertising
Rent
Salaries
Cups
Utilities

Use the break-even formula to calculate the break-even units if fixed costs are $12,000 and you are selling coffee for $3.60 at a cost of $0.40 per cup.

3. Using the same fixed and variable costs as in question 2, what is the new

break-even point if price is lowered to $2.90?

You can calculate a break-even price if you have an estimate of the number of units you will sell. The revised break-even formula is:

Break-even Price= Variable Cost+Fixed Costs / Projected Units

4. Using the fixed and variable costs from question 2, what is the break

-even price if you project that you will sell 3,000 cups of coffee?

5. How can knowing the break-even units help you with other decisions?

Answer 1

Formula sheet

A	B	C	D	E	F	G	H	I	J	K
2
3
4		1)
5			F or V
6		Coffee	V	(Coffee Cost change with additional coffee sold)
7		Advertising	F
8		Rent	F
9		Salaries	F
10		Cups	V
11		Utilities	F
12
13		2)
14
15		Breakeven units are number of units that company needs to produce to cover its fixed and variable costs.
16		Breakeven units can be calculated using the following formula:
17
18
19
20
21		Calculation of contribution margin per unit:
22		Price of the product	3.6
23		Variable cost of the product	0.4
24		Contribution margin per unit	=Price of the product-Variable cost per unit
25			=D22-D23	=D22-D23
26
27		Hence contribution margin per unit	=D25
28
29
30		Calculation of breakeven unit:
31		Fixed Cost	12000
32		contribution margin per unit	=D27
33
34		Break-even Units	=Fixed Costs/Contribution margin per unit
35			=D31/D32	=D31/D32
36
37		Hence breakeven units is	=D35
38
39		3)
40
41		Calculation of contribution margin per unit:
42		Price of the product	2.9
43		Variable cost of the product	0.4
44		Contribution margin per unit	=Price of the product-Variable cost per unit
45			=D42-D43	=D42-D43
46
47		Hence contribution margin per unit	=D45
48
49
50		Calculation of breakeven unit:
51		Fixed Cost	12000
52		contribution margin per unit	=D47
53
54		Break-even Units	=Fixed Costs/Contribution margin per unit
55			=D51/D52	=D31/D32
56
57		Hence breakeven units is	=D55
58
59		4)
60
61		Breakeven price P should be such that it will be able to cover both fixed and variable costs i.e.
62
63		3000*P = 3000*0.40+12000
64		or
65		P	=(3000*0.4+12000)/3000	=(3000*0.4+12000)/3000
66
67		Hence breakeven price is	=D65
68
69		5)
70
71		Knowing the breakeven units helps in planning the sales quantity such the operations remains profitable for the business.
72		It also helps in deciding wether the business is feasible or not.
73