Question

n order to make a profit, a business needs to generate more revenue than is necessary to cover the costs of running their business. Companies incur two types of costs – Fixed and Variable. They are what they sound like – fixed costs aren’t directly related to sales of a particular product (think rent, insurance, or interest on debt), whereas variable costs change as revenue changes (i.e., the more Chipotle sells, the more rice and beans they have to buy!). So, a key question is what level of sales does the company have to generate in order to cover both Fixed and Variable costs and thus begin to generate a profit? This is what Break-Even analysis determines.

Calculate the breakeven volume of sales for the following example:

Suppose that your fixed costs for producing 30,000 widgets are $30,000 a year. Your variable costs are $2.20 for materials, $4 for labor, and $0.80 for overhead for a total of $7.

1. If you choose a selling price of $12.00 for each widget, how many do you have to produce to breakeven?

2. What happens if you increase the price to $13?

3. What happens if you decrease your material costs by 10%?

Answer 1

1) Variable costs changes with change in quantity of units however fixed costs are constant and they do not change with change in production of units.

Break even units are sales at which there is no profit no loss

Total sales= Total variable cost+fixed cost

Fixed costs = $30,000

Variable cost = $7

selling price=$12

Break even units = fixed costs/ contribution margin per unit

contribution margin per unit = sales-variable costs

=$12-$7

=$5

Break even units = $30,000/$5

=6,000 unts

2)Price=$13

contribution margin per unit = sales-variable costs

=$13-$7

=$6

Break even units = $30,000/$6

=5,000 unts

3) variable cost = ($2.20*90%)+$4+$0.80

=$6.78

contribution margin = $13-$6.78

=$6.22

breakl even units = $30,000/6.22

=4,823 units

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