CH06

MARKETING WANTS ANOTHER $50,000

What will they do with it?How will it affect sales volume?What is the impact on our bottom line?

WHAT DOES IT MEAN TO “BREAK EVEN”

Total revenues = total expensesProfit = $0There is one sales volume at which this relationship is trueThis is called the “breakeven point”

TO CALCULATE THE BREAKEVEN POINT

Use the equation approach

Sales Revenue – Variable expenses – Fixed expenses = Operating income

(SP×units sold) – (VC×units sold) – FC = $0[(SP – VC)×(units sold)] – FC = $0

(CM/unit×units sold) – FC = $0

• Solve for units sold, which equals the breakeven point

• Why is profit set to $0?

$20x - $16x - $168,000 = 0

x = 42,000 jerseys

BREAKEVEN POINT FOR UNIVERSAL SPORTS EXCHANGE

$4x - $168,000 = 0

FCCM/Unit

= Breakeven in units

SHORTCUTS…

$168,000$4 = 42,000 jerseys

SHORTCUTS…

FCCMR

= Breakeven in sales $

$168,0000.2 = $840,000

LET’S LOOK AT BREAK EVEN GRAPHICALLY

Current sales – Breakeven sales

MARGIN OF SAFETY

What does this mean?

52,500 – 42,000 = 10,500 jerseys$1,050,000 – $840,000 = $210,000

WHAT DOES IT MEAN TO “BREAK EVEN”

Total revenues = total expensesProfit = $0There is one sales volume at which this relationship is trueThis is called the “breakeven point”

Is it 

true??

Is it always true??

PRACTICE BREAKING EVEN

Exercise 3-2

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At a break-even point of 400 units sold, variable expenses were $4,000 and fixed expenses were $2,000. What will the 401st unit sold contribute to profit?A. $0B. $5C. $10D. $15

At a break-even point of 400 units sold, variable expenses were $4,000 and fixed expenses were $2,000. What will the 401st unit sold contribute to profit?A. $0B. $5C. $10D. $15

Break-even point (units) = Fixed expenses Contribution margin per unitSubstituting:400 = $2,000 Contribution margin per unitContribution margin per unit = $5

Jatry Corporation's budgeted sales are $300,000, its budgeted variable expenses are $210,000, and its budgeted fixed expenses are $60,000. The company's break-even in dollar sales is:

A. $200,000B. $330,000C. $210,000D. $270,000

Jatry Corporation's budgeted sales are $300,000, its budgeted variable expenses are $210,000, and its budgeted fixed expenses are $60,000. The company's break-even in dollar sales is:A. $200,000B. $330,000C. $210,000D. $270,000

Contribution margin = $300,000 - $210,000 = $90,000Contribution margin ratio = $90,000 $300,000 = 30%Break-even in total sales dollars = Fixed expenses Contribution margin ratio = $60,000 30% = $200,000

LET’S REVIEW THE PROFIT EQUATION

SP(units sold) – VC(units sold) – FC = profit

HOW MUCH DO I HAVE TO SELL TO MAKE $X?

This is called the “target income” questionUse the breakeven formula and treat your target pretax income as additional fixed costs

FC + Target IncomeCM / unit = required sales

To find the sales dollars required to attain the target income, use the CMR rather than the CM / unit.

WHAT ABOUT TARGET NET INCOME?

You must adjust net income to pretax incomeDivide target net income by (1 - tax rate)Solve as before

Total FC + = required sales

CM / unit

Target net income1 – tax rate

TARGET PRACTICE

Wimpee’s Hamburger Stand sells one burger, the Super Tuesday Burger, for $3.00. If total variable expenses are $1.75 per hamburger and total monthly fixed expenses are $25,000, how many burgers would Wimpee have to sell each month:

►To break even?►To earn a pretax operating income of $6,000?

►To break even?$3*Z-$1.75*Z-$25,000=0$1.25*Z=$25,000Z=20,000 units

►To earn a pretax operating income of $6,000?$3*Z-$1.75*Z-$25,000=$6,0000$1.25*Z=$31,000Z=24,800 units

WHAT IF…

Suppose Wimpee has never sold more than 21,000 Super Tuesday Burgers in a single month.

How likely is it that he will achieve the desired $6,000 target operating income?What can he do to improve his chances of reaching his $6,000 target operating income?

CVP AND THE SUPPLY CHAIN

How do the CVP decisions of supply chain partners affect each other?For example, consider the jerseys that Universal Sports Exchange purchases from C&C Sports.• What happens if C&C Sports increases the selling

price?• What happens if Universal Sports Exchange decides

to use a cheaper supplier?

CVP ANALYSIS

Stands for cost-volume-profitA tool to determine the impact of changes in sales volume, costs, or sales mix on net incomeUseful for evaluating decision alternatives

THREE APPROACHES TO CVP

Prepare a contribution format income statement before and after implementing the changesPrepare a partial contribution format income statement that includes only those items that change (called the “incremental approach”)Compare the current total contribution margin with the proposed total contribution margin, then adjust for changes in fixed expenses

OPERATING LEVERAGE

Firms sometimes have the option to trade fixed costs for variable costsHigher levels of fixed costs introduce higher levels of riskMeasures the magnitude of change in operating income for a given percentage change in sales revenue

Degree of operating leverage = Contribution marginNet operating income

WHY DO WE CARE ABOUT OPERATING LEVERAGE?

MULTIPRODUCT CVP

Rarely does a company produce a single productSince not every product will have the same contribution margin, we have a problem when more than one product is produced

WHAT IS “SALES MIX”?

The “bag” or “package” of goods soldFor example:• For every dining room table sold, the company also

sells 4 chairs• For every computer sold, the company also sells a

monitor and a printer• For every pair of athletic shoes sold, Landon Sports

sells 4 baseball jerseys

USE THE PROFIT EQUATION…WITH ADJUSTMENTS

CM(jerseys) + CM(shoes) – FC = OI

Product PriceVariable

CostContribution

MarginJerseys $20 $16.00 $4.00Shoes $45 $38.70 $6.30

DETERMINE THE SALES MIX

$4.00(4x) + $6.30(x) – FC = OI

ProductContribution

Margin Sales MixAdjusted

Contribution MarginJerseys $4.00 4x $16.00xShoes $6.30 1x $ 6.30x

$16x + $6.30x – FC = OI

4x = 32,000 jerseys

CALCULATING THE BREAKEVEN POINT

ProductContribution

Margin Sales MixAdjusted

Contribution MarginJerseys $4.00 4x $16.00xShoes $6.30 1x $ 6.30x

x = 8,000 shoes$22.30x = $178,400

$16x + $6.30x– $178,400 = $0

LIMITING ASSUMPTIONS OF CVP ANALYSIS

All costs can be divided into fixed and variable componentsAll cost and profit functions are linear throughout the relevant rangeSales mix will remain constant

CHANGES EXAMINED USING CVP

Change in sales priceChange in sales volumeChange in variable costs per unitChange in fixed costsChange in sales mixAny combination of the above

Remember to always use “constant” forms – SP/unit, VC/unit, Total FC – when doing CVP analysis

TIME TO MIX IT UP

© Danny Smythe/iStockphoto

Kitchenware, Inc., sells two types of water pitcher, plastic and glass. Plastic pitcher cost the company $15 and are sold for $30. Glass pitcher cost $24 and are sold for $45. All other costs are fixed at $982,800 per year. Current sales plans call for 14,000 plastics and 42,000 glass pitchers to be sold in 2013. How many pitcher from each type must be sold to break even in 2013?

($30 – $15)x + ($45 – $24)3x – $982,800 = 0$15x + $63x = $982,800

x = 12,600

Kitchenware’s sales mix is 14,000 plastic pitchers and 42,000 glass pitchers, or a sales mix of 1 to 3.

plastic pitchers = x = 12,600; glass pitchers = 3x = 37,800

HOW MANY PITCHER FROM EACH TYPE MUST BE SOLD TO BREAK EVEN IN 2013?

($30 – $13)x + ($45 – $24)3x – $982,800 = 0$17x + $63x = $982,800

x = 12,285plastic pitchers = x = 12,285; glass pitchers = 3x = 36,855

Kitchenware has just received an offer from a new supplier that is offering plastic pitchers for $13. What would be the new breakeven point if manager switched to the new supplier?

ECONOMICS OF PRICE

WHAT WILL YOU PAY?

Pricing is based on what the customer is willing to pay, not on what the product costs to produce!

COST‐PLUS PRICING

Start with the cost to produce the productAdd a markup to the cost to arrive at priceBe clear about what cost you use in the markup calculation

Product Cost+ Markup= Sales Price

CALCULATING MARKUP PERCENTAGE

Sales price – CostCost

= Markup %

$20.00 - $14.80$14.80 = 35%

$36.00 + $12.60 = $48.60

CALCULATING PRICE USING MARKUP %

Cost + (Cost × Markup %) = Price

$36.00 + ($36.00 × 35%) = Price

ISSUES WITH COST‐PLUS PRICING

What if customers are willing to pay more than the calculated price?Cost-plus pricing does not recognize the value provided to the customer; it recognizes a return to the sellerThe costs of the seller’s inefficiencies are borne by the customers

TARGET COSTING

Start with an estimate of the price customers will pay• Subtract the desired markup• The result is the target, or maximum, product cost

If you can produce the product for the target cost, go forwardThis is calculated before the product is designed and manufactured

LET’S PRICE

© Chris Pethick/iStockphoto

Pet designs makes various accessories for pets. Their trademark product, PetBed, is perceived to be high quality but not extravagant, and is sold in variety of pet stores. Wanda, the marketing manager, has convinced her boss that they are missing an important segment of the market by not increasing the quality. PetBeds sell for $45 each with estimated gross margin of $15.Higher quality PetBed will sell for $78 and the cost $58.

cost of original pet bed = $45 – $15 = $30

markup percentage = $15$30

= 50% markup on COGS

price of high-end bed = $58 × 1.5 = $87

If the firm uses cost-plus pricing and prices most products like the original Pet Bed, what should be the price of the high-end PetBed?

If pet Designs wants to preserve the existing gross marginPercentage, what is the target cost at a market price of $78?

b. current gross margin = $15$45 = 1/3; COGS = 2/3

high-end bed target cost of goods sold = 2/3 × $78 = $52

Pet Designs could•redesign the high-end bed to reduce the cost to produce the bed;•accept a lower gross margin percentage; or, •not make the bed

Based on prior answers, what are Pet Designs’ alternatives?