Finance for Non-Financial Managers, 6th edition
PowerPoint Slides
to accompany
Prepared by
Pierre Bergeron, University of Ottawa
Copyright © 2011 Nelson Education Limited
Finance for Non-Financial Managers, 6th edition
CHAPTER 5
PROFIT PLANNING AND
DECISION-MAKING
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Profit Planning and Decision-Making
Chapter Objectives
1.
Explain various cost concepts related to break-even analysis
such as fixed and variable costs, the relationship between
revenue and costs, the contribution margin, the relevant
range and relevant costs.
1.
Draw the break-even chart and calculate the break-even
point, the cash break-even point and the profit break-even
point and how they can be applied in different organizations.
1.
Differentiate between different types of cost concepts such
as committed and discretionary costs, controllable and noncontrollable costs, and direct and indirect costs.
Chapter Reference
Chapter 5: Profit Planning and Decision-Making
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Relevance of Break-Even Analysis
Break-even analysis helps to:
1. Price existing or new products and services.
2. Decide whether to introduce a new product or service,
open a new plant, hire a sales representative, open a new
sales office, launch an advertising program.
3. Modernize or automate an existing plant.
4. Expand an existing plant.
5. Change the cost structure (fixed versus variable).
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1. Fixed and Variable Costs
Standby costs
Variable costs
Direct costs
Out-of-pocket costs
Volume costs
Characteristic
Characteristic
Element of fixedness and must be paid
with passage of time.
Vary almost automatically with volume.
Rent, interest, insurance, property
taxes, office salaries, depreciation,
telephone
Sales commission, direct labour,
packing material, electricity, overtime
premiums, equipment rental, truck
expenses
Fixed costs
Period costs
Constant costs
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Connection Between Revenue and Costs
Factors that affect profit:
1. Volume of production
2. Prices
3. Costs (fixed and variable)
4. Changes in product mix
Cost per Unit
(in $)
G
16
E
14
F
C
12
10
H
D
A
B
40
60
80
100
% of Capacity
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The Contribution Margin
Revenue
$ 1,000,000
Less variable costs:
Direct material
Direct labour
($ 500,000)
(250,000)
Total variable costs
PV Ratio
(750,000)
Contribution margin
250,000
$250,000
$1,000,000
Less fixed costs:
Manufacturing
(150,000)
Administration
(50,000)
Total fixed costs
Operating profit
.25
(200,000)
$ 50,000
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PV ratio
2. J. Smith’s Break-Even (Taxi Driver)
$
Fixed costs
Car payment
(principal or depreciation)
Interest
Costs/Revenue
Insurance
Revenue
$ 10.00
Variable costs
Contribution margin
$ 2.00
$ 8.00
$
15,000
$
8.00
=
1,875 trips
Break-even
point
Dispatcher fees
Variable
costs
Variable costs
Gas
Revenue
$10.00
Total
costs
$2.00
$15,000
Maintenance &
repairs
$ 45,000
5,625 trips
=
$ 8.00
Trips
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Fixed
costs
6,000
J. Smith’s Break-Even (Taxi Driver)
No salary
No. of trips
With salary
With salary
1,875
5,625
6,000
Revenue ($10.00)
$ 18,750
Variable costs ($2.00) ($ 3,750)
$ 56,250
($ 11,250)
$ 60,000
($ 12,000)
$ 15,000
$ 45,000
$ 48,000
($ 15,000)
($ 15,000)
($ 15,000)
Salary
0
($ 30,000)
($ 30,000)
Profit
0
0
$ 3,000
.80
.80
.80
Contribution margin
Fixed costs
P.V. Ratio
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Finding the Break-Even Point Using the Formula
Unit selling price
$ 15.00 (P)
Fixed costs
$200,000 (F)
Unit variable costs
$ 10.00 (V)
Break-even calculation
Step 1:
Contribution margin
Selling price
$15.00
Variable costs
$10.00
Contribution margin
$ 5.00
÷
Step 2:
$200,000
$5.00 = 40,000 units (volume)
Step 3:
40,000 units X $15.00 = $600,000 (sales revenue)
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Break-Even Point Calculation
In
Units
B.E.P. =
B.E.P. =
Fixed costs
Price per unit sold – Variable cost per unit
or unit contribution
$200,000
$15.00 - $10.00
= 40,000 units
X $15.00
$ 600,000
In
revenue
Step 1: Find the PV ratio
PV = Unit contribution =
Unit selling price
$5.00
$15.00
= .333
Step 2: Find the revenue break-even point
B.E.P. =
Fixed costs
PV
=
$200,000
.333
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= $600,000
Break-Even Point By Using the PV Ratio
Revenue
Variable costs
Contribution margin
Finding the break-even point
when units are not known,
you need to re-structure the
statement of income
Fixed costs
Profit/loss
$
$
$
$
$
600,000
400,000
200,000
200,000
0
Step 1: Find the PV ratio
PV =
Contribution
Revenue
= $200,000 = .333
$600,000
Step 2: Find the revenue break-even point
B.E.P.
=
Fixed costs
PV
=
$200,000
.333
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= $600,000
Break-Even Point (Retail Store)
Suits Jackets Shirts
800
200
700
No. of units
Unit selling price $300
$150
$50
Ties
500
$50
Socks Overcoats
2,500
500
$8
Total
$300
Revenue
$500,000
Variable costs
Purchases
($275,000)
Sales commission
(25,000)
Total variable costs
($300,000)
Contribution margin
$200,000
Fixed costs
(rent, telephone, salaries, security system)
Profit
($100,000)
$100,000
Contribution margin
Revenue
Fixed costs
PV ratio
=
=
$200,000=
$500,000
$100,000=
.40
.40 or $0.40
50%
of objective
$250,000
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OK!!!
Cash Break-Even Point
In
Units
Fixed costs -
Depreciation
Price per unit sold – Variable cost per unit
$ 200,000 - $50,000 = $150,000 = 30,000 units
$15.00 - $10.00 $5.00
In
revenue
Fixed costs - Depreciation
PV
=
$150,000 = $450,000
.333
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Profit Break-Even
In
Units
Fixed costs + Profit objective
Price per unit sold – Variable cost per unit
$200,000 + $20,000
$220,000
=
$15.00 - $10.00
$5.00
= 44,000 units
In
revenue
Fixed costs + Profit objective
PV
=
$220,000
= $660,000
.333
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Sensitivity Analysis
Base case
Break-even
Break-even
in units
in revenue
40,000
$600,000
50,000
$750,000
36,364
$563,642
34,782
$521,730
Change in
Fixed costs
(increased by $50,000 to $250,000)
Selling price
(increased by $0.50 to $15.50)
Variable costs
(decreased by $0.75 to $9.25)
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Break-Even Wedges
Company A
Company B
Revenue
Revenue
Total costs
PV = .40
Total costs
PV = .30
Fixed costs
Fixed costs
Company C
Company D
Revenue
Total costs
Revenue
Total costs
PV = .30
PV = .40
Fixed costs
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Fixed costs
Where Break-Even Analysis Can be Used
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Company-wide
Trucking operation
Plant
Direct mail advertising
District or sales territory
Taxi business
Retail store
Movie theatre
Production centre
Advertising program
Department store
Travel agency
Product/division
Hotel business
Service centre
Restaurant business
Machine operation
Book publishing
Airline business
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3. Other Cost Concepts
Committed costs: Costs that must be incurred in order to operate a
business.
Discretionary fixed costs: Costs that can be controlled by managers.
Controllable costs: Costs that operating managers are accountable for.
Non-controllable costs: Costs that are not under the direct control of
managers.
Direct costs: Materials and labour expenses that are directly incurred when
making a product or providing a service.
Indirect costs: Costs that are necessary in the production cycle but that
cannot be clearly allocated to specific products or services.
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