Managerial Accounting
Insights from
Fixed and Variable
Costs
Today’s Agenda
• Ramona’s Charity Auction
– Simple calculation; do all entrepreneurs do it?
• GM Jobs Bank
– The Danger of Fixed Costs
• Breakeven calculations for Chinese airlines
• McDonald’s Breakeven
– Number of customers per store per hour
– Sales Price or Contribution Margin?
Breakeven Analysis
Ramona’s Charity Banquet
Ramona helped organize a charity banquet and raffle.
• The raffle prize was a brand new car costing $18,000. (This
was back in 1985, so that was a pretty nice car.)
• The caterer charged $40 per person for the banquet.
• The charity sold tickets to the banquet for $250 each.
Questions
1. How many people had to attend the banquet in order for
the charity to break even?
2. Do you think the charity performed the breakeven
calculation? Explain.
Breakeven Computation
Total Fixed Costs
--------------------------------Contribution Margin per Unit
(Sales Price per unit - Variable Cost per unit)
Breakeven Analysis
Ramona’s Charity Banquet
$18,000 for the car
--------------------------------Contribution Margin per Person
($250 per person - $40 per person)
$18,000 ÷ $210 per person = 86 people to breakeven
Breakeven Analysis
Ramona’s Charity Banquet
Do you think the charity performed the breakeven
calculation?
Almost certainly …..
NOT.
Why not?
• Numbers are boring; starting a business or organizing a
charity banquet is supposed to be exciting.
• Numbers are scary.
• Many people (most people?) just don’t think of using
data in making decisions.
Breakeven Analysis
Ramona’s Charity Banquet
A HUGE benefit of financial analysis
in general and breakeven analysis
in particular is that it can
Counteract the natural
over-optimism of
entrepreneurs.
The Dangers of Fixed Costs
General Motors Jobs Bank
• Jobs Bank initiated in 1984.
• Insurance against overseas outsourcing of union jobs.
• At the time, the Big Three had 75% U.S. market share.
Questions
1. Is direct labor a fixed cost or a variable cost?
2. Does the existence of the Jobs Bank change your
answer to (1)? Explain.
3. Under what circumstances would the Jobs Bank
become a very costly program for the Big Three?
The Dangers of Fixed Costs
General Motors Jobs Bank
1. Is direct labor a fixed cost or a variable cost?
Traditionally, direct labor is
the perfect example of a
variable cost.
The Dangers of Fixed Costs
General Motors Jobs Bank
2. Does the existence of the Jobs Bank change your
answer to (1)? Explain.
• From the standpoint of the UAW, the entire point
of the Jobs Bank was to change direct labor from a
variable cost to a fixed cost.
• Thus, the Big Three automakers would know that
even if production was outsourced overseas, they
would still have the same fixed labor costs in the
United States.
The Dangers of Fixed Costs
General Motors Jobs Bank
3. Under what circumstances would the Jobs Bank
become a very costly program for the Big Three?
•
•
The Jobs Bank would become very costly if production
were to drop and yet Jobs Bank workers still had to be
paid.
Combined U.S. market share for the Big Three fell below
50% for the first time in 2007. In 2006, GM itself had 7,500
workers in the Jobs Bank. Including the cost of benefits, the
Jobs Bank cost GM about $1 billion in 2006 alone … $1
billion to pay workers who were not working on building
cars.
The Dangers of Fixed Costs
For A Small Business Owner
Fixed costs have to be paid even when …
•
•
•
•
•
•
You are just getting your business started.
Your business is experiencing a seasonal
downturn.
The local economy is a little slow right now.
You want to take a vacation.
You get sick and can’t run your business.
Your customers are a little slow in paying you.
The Secret to Financial Security
Spend less than you make!!!!
One key practice: Keep Fixed Costs Low
•
•
•
Housing payment
Installment payments for credit purchases
Cable/Internet/Phone bill
China Airline Industry
Fixed and Variable
Costs
China Airline Industry
Three Largest Chinese Airlines
Air China
State ownership 52.2%
Major hubs
Beijing
Shanghai
Chengdu
Stock listings
Shanghai
Hong Kong
London
China Southern
50.3%
Guangzhou
Beijing
China Eastern
59.7%
Shanghai (Pudong)
Shanghai (Hongqiao)
Shanghai
Hong Kong
New York
Shanghai
Hong Kong
New York
China Airline Industry
Three Largest Chinese Airlines
China Airline Industry
Cathay Pacific and Singapore Airlines
Cathay Pacific
– Founded in 1946. “Over the Hump”
– Headquarters in Hong Kong
– Significant ownership by Swire Group
– Acquired Dragonair, complex transaction
Singapore Airlines
– Headquarters in Singapore
– Majority owned by Singapore government
China Airline Industry
The Importance of Shanghai
–How large is Shanghai?
• Between 24 and 34 million people, depending on
whether you count just the city or the entire
metropolitan area.
• Most populous city in China
–Is Shanghai important to Chinese
business?
• The key Chinese financial center (in competition
with Hong Kong)
• One of the world’s largest ports
Breakeven Application
Airline Industry in China
For 2007 (in billions)
Revenue
¥
Variable costs
Fixed costs
Net income
Passengers carried (thousands)
Average number of seats per flight
Average length of a flight (kilometers)
Number of flights
¥
(RMB)
(RMB)
(RMB)
China
Eastern
43.1 ¥
(2.9)
(40.0)
0.20 ¥
China
Southern
54.5 ¥
(4.1)
(48.4)
2.00 ¥
Air China
51.3 ¥
(2.8)
(44.4)
4.10 ¥
39,161.4
163
1,460
327,426
56,903.0
178
1,436
470,043
37,256.2
164
1,880
276,446
(RMB restated) (RMB restated)
Cathay Singapore
Pacific
Airlines
70.8 ¥
80.8
(2.8)
(4.0)
(61.3)
(66.0)
6.70 ¥
10.80
23,253.0
264
3,518
119,943
19,120.0
311
4,785
76,471
Breakeven Application
Airline Industry in China
For 2007
¥
Variable cost per passenger
¥
Contribution margin per passenger ¥
Revenue per passenger
Contribution margin percentage
Fixed cost per flight
¥
(RMB)
(RMB)
China
Eastern
1,101
74
1,027
93.3%
122,165
China
Southern
958
72
886
92.5%
102,969
¥
¥
¥
¥
(RMB)
¥
¥
¥
¥
Air China
1,377
75
1,302
94.6%
160,610
(RMB restated) (RMB restated)
¥
¥
¥
¥
Cathay
Pacific
3,045
120
2,925
96.1%
511,077
¥
¥
¥
¥
Singapore
Airlines
4,226
209
4,017
95.1%
863,067
Breakeven Application
Airline Industry in China
Questions
1. Does an airline ever want to see a plane take off with empty
seats on board? Explain.
2. Using the data for fixed cost per flight and for contribution
margin per passenger, compute the breakeven number of
passengers per flight for China Eastern.
3. Using your answer in (2) and the average number of seats
per flight, for China Eastern compute the “breakeven
passenger load factor” which is the percentage of seats that
must be purchased, on average, for the airline to break even.
4. Comment on the results of your computation in (3). Do you
think that the “breakeven passenger load factor” is an
important number for an airline?
Breakeven Application
Airline Industry in China
1. Does an airline ever want to see a plane take off with empty
seats on board? Explain.
NO!!
The variable cost of putting a passenger
in a seat is just RMB70 for the Chinese
airlines.
Breakeven Application
Airline Industry in China
2. Using the data for fixed cost per flight and for contribution margin per passenger,
compute the breakeven number of passengers per flight for China Eastern.
Fixed cost per flight
¥
÷ Contribution margin per passenger ¥
Breakven number of passengers
122,165 ¥
1,027 ¥
102,969 ¥
886 ¥
160,610 ¥
1,302 ¥
511,077 ¥
2,925 ¥
119.0
116.2
123.4
174.7
863,067
4,017
214.9
Breakeven Application
Airline Industry in China
3. Using your answer in (2) and the average number of seats per flight, for China
Eastern compute the “breakeven passenger load factor” which is the percentage
of seats that must be purchased, on average, for the airline to break even.
Breakven number of passengers
÷ Average number of seats per flight
119.0
163
116.2
178
123.4
164
174.7
264
214.9
311
Breakeven passenger load factor
73.2%
65.3%
75.2%
66.2%
69.1%
Breakeven Application
Airline Industry in China
4. Comment on the results of your computation in (3). Do you think that the
“breakeven passenger load factor” is an important number for an airline?
• YES!!
• Many airlines publicly report their “breakeven
passenger load factor.”
• This one number is an efficient way to summarize
how an airline is balancing its revenues and its costs
in changing economic conditions.
Breakeven Application
McDonald’s
6,399 company-owned stores
(in millions of U.S. dollars)
Sales
Food & Packaging (variable)
Payroll & Benefits:
Variable
Fixed
Occupancy (fixed)
Operating income
2010
$ 16,233
(5,300)
$
(3,247)
(874)
(3,638)
3,174
Breakeven Application
McDonald’s
Questions
1. What is McDonald’s contribution margin ratio?
2. The average sale per customer visit to McDonald’s is $3.28.
What is the contribution margin per visit?
3. With 6,399 company-owned stores, what is the fixed cost
per store per year?
4. Assume that each store is open 16 hours per day, 365 days
per year. What is the fixed cost per store per hour?
5. Combine your answers to (2) and (4). How many customers
must visit the average McDonald’s store PER HOUR in order
for McDonald’s to break even?
Breakeven Application
McDonald’s
1. What is McDonald’s contribution margin ratio?
(in millions of U.S. $)
Sales
Food & Packaging (variable)
Payroll & Benefits (variable)
Contribution Margin
Payroll & Benefits (fixed)
Occupancy (fixed)
Operating income
Contribution Margin Ratio
Contribution Margin
÷ Sales
$
2010
16,233
(5,300)
(3,247)
7,686
(874)
(3,638)
3,174
$
$
7,686
16,233
$
47.3%
Breakeven Application
McDonald’s
2. The average sale per customer visit to McDonald’s is $3.28.
What is the contribution margin per visit?
Sales per customer
× Contribution Margin Ratio
$
3.28
47.3%
Contribution margin per customer $
1.55
Breakeven Application
McDonald’s
3. With 6,399 company-owned stores, what is the fixed cost
per store per year?
Payroll & Benefits (fixed)
Occupancy (fixed)
Total Fixed Costs
÷ Number of stores
Fixed cost per store per year
(in millions)
$
874
3,638
$
4,512
6,399
$ 705,110
Breakeven Application
McDonald’s
4. Assume that each store is open 16 hours per day, 365 days
per year. What is the fixed cost per store per hour?
Fixed cost per Store per year
$ 705,110
÷ 365 days × 16 hours per day
5,840
Fixed cost per store per hour
$
120.74
Breakeven Application
McDonald’s
5. Combine your answers to (2) and (4). How many customers must visit the
average McDonald’s store PER HOUR in order for McDonald’s to break even?
$120.74 fixed cost per store per hour
---------------------------------------------------$1.55 contribution margin
per customer
78 customers
per store per hour breakeven
McDonald’s
One More Dollar to Spend
Assume that a customer has one more dollar
in her or his pocket to spend. Would
McDonald’s prefer that the customer spend
that dollar on a hamburger or on french
fries? Explain.
McDonald’s
One More Dollar to Spend
Which should the company care about:
• Sales?
• Contribution Margin?
Today’s Agenda
• Ramona’s Charity Auction
– Simple calculation; do all entrepreneurs do it?
• GM Jobs Bank
– The Danger of Fixed Costs
• Breakeven calculations for Chinese airlines
• McDonald’s Breakeven
– Number of customers per store per hour
– Sales Price or Contribution Margin?