Activity 6.1 – Break Even Analysis Part 1 – Variable and Fixed Costs Break-even analysis is a management tool used to determine the volume of sales necessary to cover fixed costs. Break-even analysis is also useful in estimating profit given a particular production or sales volume. Break-even analysis assumes that certain costs – variable costs – vary in direct proportion to the number of units produced or sold and that other costs – fixed costs – remain constant regardless of production or sales volume within the relevant range. It is important, therefore, to distinguish between variable and fixed costs, recognizing that some costs may be semifixed or semivariable. Identify the following costs as either fixed, variable, or semifixed/semivariable. Rent on office building Telephone service, which includes a base rate, plus a charge for each call placed Commissions to sales and marketing personnel Direct manufacturing materials Salaries for administrative personnel Direct manufacturing labor Straight-line depreciation on plant equipment Property taxes on factory site Maintenance for delivery vehicles Factory supervisor wages Part 2 – Contribution Margin The contribution margin refers to the excess of revenue over variable costs for each unit of production, that is, how much is left from each sales dollar, after paying the variable (or direct) costs, to contribute to the coverage of fixed costs? When the contribution margin is known, one can calculate how many units must be produced or sold to make a profit, or calculate how much profit (or loss) the company will experience at any given level of production or sales. A simple formula for contribution margin, which is used to calculate the break-even point in number of units to be sold or produced, is: Unit contribution margin = Sales price per unit – Variable cost per unit You operate the PACESetters Sports Camp, which provides basic instructions to boys and girls ages 10-18 in three divisions. A college coach supervises each division. Camp runs from 9-4 each day. Campers bring their own lunch. Campers pay $110 each for a 5 day program. Each camper receives a shirt and a ball. Last year you had 190 campers for which you had 20 counselors and you plan to hire the same number this year. (You hire players from local colleges and you normally have all of these people under contract prior to the end of camp registration.) You have identified the following costs: Miscellaneous $ 400.00 Director salary 1,500.00 Insurance per camper 5.00 Camp shirt 7.00 Ball 12.00 Awards 200.00 Trainer 600.00 Training supplies 100.00 plus $2.00 per camper Coaches (1 per division) 1,000.00 each Counselors 250.00 each Determine your fixed and variable costs and then calculate your unit contribution margin. Calculate total fixed costs. Part 3 – Break-even Point The break-even point is the point at which total sales dollars equals total costs, fixed and variable. When sales dollars exceed total costs, there is a profit, or net income. The break-even point may be expressed in terms of number of units (i.e. how many units must we sell in order to break even) or in terms of dollars (i.e. what level of sales dollars must we show in order to break even). The break-even point may be calculated as follows: Break-even point in units = Total fixed costs Unit Contribution margin Unit contribution margin = Price per unit – variable cost per unit 1. Calculate the break-even point in units for PACESetters, Inc. 2. Given the sales forecast comparable to last year, will PACESetters earn a profit. If so, how much? 3. Due to competition from another camp, you feel that you may have to lower your price. If your sales forecast is correct, how low can you go and still break-even?
