scc2301 ch2 l05 breakeven
TRANSCRIPT
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Break Even Analysis
Lecture 5
This lecture is part of Chapter2:
Budgets, Running aCompany
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Todays Lecture
Fixed versus Variable Costs
Break Even Analysis
Learn how to use the Solver in Excel
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Break-Even Analysis
An important part of running a company is the
determination of how the company should be
financed and how the prices of the products the
company sells should be set.
Clearly, in order to do this properly a sound
financial analysis is necessary.
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Types of costs
It is essential to realize that there are two basic types
of costs a company incurs.
Variable CostsFixed Costs
Variable costs are roughly proportional to a
companys sales. I.e. the cost per unit remains
roughly constant.
Fixed costs remain roughly the same regardless of
sales. I.e. the cost per unit is inversely proportional
to sales.
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Types of costs
Total Costs
Variable Costs
Fixed Costs
Sales
Sales Value
A simple graph but important to understand!
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Break-Even Analysis
Commonly, the Break-even point is defined to be
the level of sales where:
Revenues = Expenses
Let us have a look at a simple example.
Aunt Petunia opens a flower shop.
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Break-Even Analysis
Fixed Costs:
Rent: 5,000 Utilities: 300
Helper: 1,500
Variable Costs:
Flowers: 40% of selling price
So we know that:
Selling price cost of flowers rent utilities
helper = 0
when she breaks even
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Break Even Analysis
A B C D E F G H I
2
3
4
5
6 Sales Cost as percentage of
7 Cost of Sales 0 sales 40%
8 Rent 5000
9 Utilities 300
10 Helper 1500
11 Net Income -6800
12
Auntie Petunia Flowers - Break even Analysis
Lets enter the last line into the spread sheet
We learned something in the
last lesson. Its good to put the
assumptions separately.
=E6*$H$7But!!!?? Im not a
Mathematician!
How am I going to find the
value for E6 so that E11 = 0?
=E6-E7-E8-E9-E10
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Break Even Analysis
A B C D E F G H I
2
3
4
5
6 Sales 12600 Cost as percentage of
7 Cost of Sales 5040 sales 40%
8 Rent 5000
9 Utilities 300
10 Helper 1500
11 Net Income 760
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Auntie Petunia Flowers - Break even Analysis
Piece of cake! Trial and error!
Oops! Not as easy as I thought.
Especially if H7 is not a nice
number like 40%. Is there a better way?
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The Solver
We could cave and write down the equation. That
would, in fact not be such a bad idea since equations are
really not as difficult to understand when one knows
what they are supposed to mean.
But *** RELIEF *** Excel has an incredibly useful
function called the solver. It will solve equations
without giving it the equations!
That was close .
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The Solver
The Solver can be found in the Tools menu of Excel. If
its not there, it can be installed by going to the Add-
ins menu item and selecting the Solver Add-in.
This is really quite self-
explanatory!
Enter the appropriatevalues for Set target
cell, Equal to and By
changing cells, and click
Solve.
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Break Even Analysis
A B C D E F G H I
2
3
4
5
6 Sales 11,333 Cost as percentage of
7 Cost of Sales 4,533 sales 40%
8 Rent 5,000
9 Utilities 300
10 Helper 1,500
11 Net Income 0
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Auntie Petunia Flowers - Break even Analysis
Let try out the Solver!
Incredible!
Like this anyone can do Math!
The break even
point is 11,333
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An Equation
The Solver is a fabulous tool, but really in business it is
beneficial to at least be open-minded about equations.
Lets give it a try! We know that:E11=E6-E7-E8-E9-E10
(Income = Sales Cost Rent Utilities Helper)
At the break even point, Net Income = 0 and hence E11
= 0
Inserting this we obtain:
0 = E6-E7-E8-E9-E10
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An Equation
We want to change E6 such that
0 = E6-E7-E8-E9-E10
is true.
Ah, if we just set E6 to the other values together the above
equation is true. Or,
E6 = E7+E8+E9+E10
is the solution to our problem.
Lets try it and go back to the situation before we used the
solver:
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Break Even Analysis
A B C D E F G H I
2
3
4
5
6 Sales 0 Cost as percentage of
7 Cost of Sales 0 sales 40%
8 Rent 5000
9 Utilities 300
10 Helper 1500
11 Net Income -6800
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Auntie Petunia Flowers - Break even Analysis
Lets fill the equation into cell E6
Oops!
What went wrong?
=E7+E8+E9+E10
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An Equation
May be Math isnt as easy as I thought
But wait, doesnt E7 depend on E6? Yes indeed, we have
defined E7 = E6 * H7 (cost of product).
Lets put this into our equation:
E6 = E7+E8+E9+E10 => E6 = E6*H7+E8+E9+E10
Or: E6 - E6*H7 = E8+E9+E10
E6 * (1 - H7) = E8+E9+E10
E6 = (E8+E9+E10) / (1 - H7)
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Break Even Analysis
A B C D E F G H I
2
3
4
5
6 Sales 11,333 Cost as percentage of
7 Cost of Sales 4,533 sales 40%
8 Rent 5,000
9 Utilities 300
10 Helper 1,500
11 Net Income 0
12
Auntie Petunia Flowers - Break even Analysis
Yosh! Lets try that again.
Yatta! It works
After all, this was quite easy wasnt it?
And now we can change H7 to play out
scenarios. Very useful indeed!
(E8+E9+E10) / (1 - H7)
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Break Even Analysis
A B C D E F G H I
2
3
4
5
6 Sales 9,714 Cost as percentage of
7 Cost of Sales 2,914 sales 30%
8 Rent 5,000
9 Utilities 300
10Helper 1,500
11 Net Income 0
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Auntie Petunia Flowers - Break even Analysis
If Aunt Petunia raises the price so that the
cost is only 30% of sales .
she can break even already at 9714. Of
course now she may be so expensive that no
one wants to buy her flowers anymore.
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The other way around
There may be times when it is better
to turn things around.
Just now, Aunt Petunia found how much she needs to sellin order to break evengivencertain cost as percentage of
sales. This is in general a good idea since for many
products the profits are more or less set.
In order to see how feasible a business is one could also
enter an expected sales amount and then see how much the
cost of the product can be in order to break even.
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Break Even Analysis
A B C D E F G H I
2
34
5
6 Sales 12,000 Cost as percentage of
7 Cost of Sales 5,200 sales 43%
8 Rent 5,000
9 Utilities 300
10 Helper 1,500
11 Net Income 0
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Auntie Petunia Flowers - Break even Analysis
With our nice equation, its fairly easy to
accomplish this:
E6 * (1 - H7) = E8+E9+E10
(1 H7) = (E8+E9+E10)/E6H7 = 1 - (E8+E9+E10)/E6
Cool! And I
thought that
FinancialAnalysis is only
for others
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Key Points of the Day
The Solver is a great tool
But Math can be very useful as well
There are two types of costs: Variable Costs
Fixed Costs
Break Even Analysis is a snap with Excel