Question

Explain how a shift in sales mix can affect a higher break even and lower net operating income?

Answer 1

A change in sales Mix can effect higher break even and lower operating income when there is a change in the level of sales Mix from high contribution margin products to low contribution margin products which in turn decreases the average contribution margin and as a result the more volume of sales is required cto cover the fixed costs which increase the level of breakeven and decrease the operating income for the company as a whole.

Let us take an example to make the image more clear

Company having two products A and B

Particular. Product A. Product B

Selling Price per Unit. 30. 50

Variable Costs per Unit. 10. 40

Contribution Margin per Unit. 20. 10

Production and Sales. 15,000. 15,000

Total Fixed Costs $ 300,000

Average contribution per Unit = Contribution Margin per Unit of A + Contribution Margin per Unit of B / 2

Average contribution Margin per Unit = ( 20+10 ) / 2 = $ 15

Break Even Point in Units = Fixed Costs / Average Contribution Margin per Unit

Break Even Point in Units = 300,000 / 15

Break Even Point in Units = 20,000 Units

Now assuming everything constant but change in sales and production only

Sales and Production. 10,000 Units of A. 20,000 Units of B

Average Contribution Margin per Unit = (1*20 + 2*10) / 3

Average contribution margin Per Unit = $ 13.33

Break Even Point in Units = Fixed Costs / Average Contribution Margin per Unit

Break Even Point in Units = 300,000 / 13.33

Break Even Point in Units = 22,506 Units

The above example clearly depicts what is being explained in words at the beginning . With a change in the sales proportion the break even point has increase which will automatically decrease the profit level due to more sales in the same sales Mix to cover the fixed costs. I hope it will clear the situation.