Bill French: Case 16-3

Bill French Case 16-3

Introduction

French, a staff accountant who was hired six months was well aware of his capabilities and took advantage of every opportunity that arose to try to educate those around him. Then, he was requested permission to make a presentation of some break-even data.

The Duo-Products Corporation had not been making use of this type of analysis in its planning or review procedures. What French had done was to determine the level at which the company must operate in order to break even.

He uses information given in past accounting records to construct his break even analysis without take into consideration with other department about the company operation.

As per Bill French: The company must be able at least to sell a sufficient volume of goods so that it will cover all the variable costs of producing and selling the goods. Further, it will not make a profit unless it covers the fixed cost as well. The level of operation at which total costs are just covered is the break-even volume. This should be the lower limit in all our planning.

Bill French: Case 16-3

Question 1 What are the assumptions implicit in Bill Frenchs determination of his companys breakeven point?

1. There was only one break-even point for the firm whether product by product or in total (he taking average of 3 products). Refer to the table below.

A Sales at full capacity (units) Sales Volume (units) Unit Sales Price Sales revenue Variable cost per unit Contribution margin per unit (Selling price variable cost per unit) Total variable cost Fixed cost Profit Ratio : Variable cost to sales Unit contribution to sales Utilization of capacity Break even points (unit) (Fixed costs / Contribution margin per unit) 600 000 $10 $6,000,000 $7.5 $2.5 ($10-$7.5)

B 400 000 $9 $3,600,000 $3.75 $5.25 ($9 $3.75)

C 500 000 $2.4 $1,200,000 $1.5 $0.9 ($2.4 - $1.5)

Aggregate 2,000,000 1 500 000 $7.2 $10,800,000 $4.5 $2.7 ($7.2 - $4.5)

$4,500,000 $960,000 $540,000 0.75 0.29 30% 384,000 ($960,000 / $2.5)

$1,500,000 $1,560,000 $540,000 0.416667 0.58333 58% 297,143 ($1,560,000 / $5.25)

$750,000 $450,000 $0 0.625 0.75 37.50% 500,000 ($450,000 / $0.9)

$6,750,000 $2,970,000 $1,080,000 0.625 0.375 75% 1,100,000 ($2,970,000 / $2.7)

2. The sales mix will remain constant.

3. Total revenue and total expenses behave in a linear manner over the relevant range.

4. There will be no significant changes in the business. Sales volume will be maintain, constant dividend for stockholders and labor union will not affect cost. 5. The increase in capacity will be allocated to Product C and Product A will be decreased. However the total fixed cost assumes to be unchanged.

Bill French: Case 16-3

Question 2 On the basis of Frenchs revised information, what does next year look like:

a. What is the break- event point?

The break-even point (BEP) is the point at which cost or expenses and revenue are equal which there is no net loss or gain, and one has "broken even". A profit or a loss has not been made, although opportunity costs have been "paid", and capital has received the risk-adjusted, expected return. It is shown graphically, at the point where the total revenue and total cost curves meet. In the linear case the break-even point is equal to the fixed costs divided by the contribution margin per unit. A Sales at full capacity (units) Sales Volume (units) Unit Sales Price Sales revenue Variable cost per unit Contribution margin per unit (Selling price variable cost per unit) Total variable cost Fixed cost Profit Ratio : Variable cost to sales Unit contribution to sales Break even points (unit) (Fixed costs / Contribution margin per unit) Note: * ** *** = Sales volume (unit) in Product C increased up to 450,000 units. = Unit Sales price was increased 100% ($2.40 x 2 = $4.80) = Fixed cost is about increased about $60,000 per month = ($60,000 x 12) + $450,000 = $720,000 + $450,000 = $1,170,000 **** = Product A will decrease 200,000 units of sales. ****400 000 $10 $4,000,000 $7.5 $2.5 ($10-$7.5) B 400 000 $9 $3,600,000 $3.75 $5.25 ($9 $3.75) C *950 000 **$4.80 $4,560,000 $1.5 $3.30 ($4.8 - $1.5) Aggregate 2 000 000 1 750 000 $6.95 $12,160,000 $3.39 $3.56 ($6.95 $3.39)

$3,000,000 $960,000 $40,000 0.75 0.25 384,000 ($960,000 / $2.5)

$1,500,000 $1,560,000 $540,000 0.42 0.58 297,143 ($1,560,000 / $5.25)

$1,425,000 $5,925,000 ***$1,170,000 $3,690,000 $1,965,000 0.3125 0.6875 354,545 ($1,170,000 / $0.9) $2,545,000 3.56 0.49 1,036,517 ($3,690,000 / $3.56)

Bill French: Case 16-3

If a business is unable to reach this level of output it will suffer a loss from this product. Any output in excess of break even generates profit for the company. It will illustrated by this equation:

BREAK-EVEN POINT = TOTAL FIXED COST + TOTAL VARIABLE COST

b. What level of operations must be achieved to pay the extra dividend, ignoring union demands? FIXED COST +TARGET PROFIT Formula: CONTRIBUTION MARGIN

Level operation to be achieved

$3,690,000 + 1,200,000 $3.56

1,373,596 units

Note: $600,000 of company profit + $600,000 on government tax.

Bill French: Case 16-3

c. What level of operations must be achieved to meet the union demands, ignoring bonus dividends? FIXED COST + TARGET PROFIT Formula: CONTRIBUTION MARGIN

Level operation to be achieved

$3,690,000 + 900,000 $3.22

1,425,465 units

Note: 1. $600,000 of company profit + $450,000 on government tax. 2. Margin Contribution = Sales price New Variables cost = $6.95 ($3.39 x 1.10) = $3.22 d. What level of operations must be achieved to meet both dividends and expected union requirements?

FIXED COST + TARGET PROFIT Formula: CONTRIBUTION MARGIN

Level operation to be achieved

$3,690,000 + 1,200,000 $3.22

1,518,633 units

Bill French: Case 16-3

Question 3 Can the break-even analysis help the company decide whether to alter the existing product emphasis? What can the company afford to invest for additional C capacity?

Product C Price Selling Price Contribution Margin Total Units Fixed Cost Can Be Covered Current Fixed Cost Maximum Investment Profit / Loss From Product A Max Investment if As loss taken

Old $2.40 0.90 950,000 $855,000 $450,000 $405,000 $500,000 Not Possible

New $4.80 3.30 950,000 $3,135,000 $450,000 $2,685,000 $500,000 $2,185,000

The break-even analysis can help the company decide whether to alter the existing product emphasis because it will allow the company to identify which product generates the highest profit for the company.

Breakeven analysis would suggest that a substantial percentage of Product A's profits go to pay for variable costs instead of fixed costs. Both Products B and C have better ratios in this regard, with C's being the highest. If the planned increase in C's production goes ahead it will take up almost 50% of the company's production capacity. We can see from the table above that the company will gain $2,185,000 profit when they decide to invest in Product C.

Bill French: Case 16-3

Question 4 Calculate each of the three products break-even points using the data in Exhibit 3. Why is the sum of these three volumes not equal to the 1,100,000 units aggregate break-even volume?

A Sales at full capacity (units) Sales Volume (units) Unit Sales Price 600 000 $10

B 400 000 $9 $3,600,000 $3.75 $5.25 ($9 $3.75) $1,500,000 $1,560,000 $540,000 0.416667 0.58333 58% 297,143 ($1,560,000 / $5.25)

C 500 000 $2.4 $1,200,000 $1.5 $0.9 ($2.4 - $1.5) $750,000 $450,000 $0 0.625 0.75 37.50% 500,000 ($450,000 / $0.9)

Aggregate 2 000 000 1 500 000 $7.2 $10,800,000 $4.5 $2.7 ($7.2 - $4.5) $6,750,000 $2,970,000 $1,080,000 0.625 0.375 75% 1,100,000 ($2,970,000 / $2.7)

Sales revenue $6,000,000 Variable cost per unit $7.5 Contribution margin per unit $2.5 (Selling price variable cost per unit) ($10-$7.5) Total variable cost Fixed cost Profit Ratio : Variable cost to sales Unit contribution to sales Utilization of capacity Break even points (unit) (Fixed costs / Contribution margin per unit) $4,500,000 $960,000 $540,000 0.75 0.29 30% 384,000 ($960,000 / $2.5)

Refer to the data above, we can see that the sums of these three volumes are not equal to the 1,100,000 unit aggregate break-even value but 1,181,143 unit. This is because each of products has different contribution margin ratio, fixed cost and sales volume.

Bill French: Case 16-3

Question 5

Is this type of analysis of any value? For what can it be use?

Breakeven analysis enables a business organization to:

1. Measure profit and loss at different levels of production and sales.

Refer to the Duo-Products Corporation, they have three product lines, A, B and C with different level of productions.

2. To predict the effect of changes in price of sales. To show to John Cooper, Production Control how unit of sales increase taken up, and hed also like to see whether theres any difference if calculations base on an analysis of individual product lines.

3. To analysis the relationship between fixed cost and variable cost.

Variable expenses increase when sales increases. Fred, Manufacturing looks toward an increase in fixed manufacturing costs of $60,000 a month.

4. To predict the effect on profitability if changes in cost and efficiency.

As per Bill, base on the break even chart, we can see the cost and profit relationship for the new volume. The main advantage of break even point analysis is that it explains the relationship between cost, production, volume and returns. It can be extended to show how changes in fixed cost, variable cost, commodity prices, revenues will effect profit levels and break even points.

Bill French: Case 16-3

Conclusion

Breakeven point is a key financial analysis tool used by business owners. Once you know the fixed and variable costs for the product your business produces, or a good approximation of them, you can use that information to calculate your company's breakeven point. It is a popular tool used by small business owners to determine how much volume of their product they must sell in order to make a profit. It is also an important part of cost-volume-profit analysis.

Breakeven analysis is the relationship between cost volume and profits at various levels of activity, with emphasis being placed on the breakeven point. The breakeven point is where the business neither receives a profit nor a loss, this is when total money received from sales is equal to total money spent to produce the items for sale. Break even analysis is a very important tool to help any firm in deciding on the best operational volume. It requires three types of costs namely the fixed cost, variable cost and selling price as Bill French puts it, the level of operation at which total costs that is, variable plus non-variable are just covered is the break even volume and it is the least volume that an organization should operate in order to remain in business.

Frankly, predicting a precise amount of sales or profits is nearly impossible due to a company's many products (with varying degrees of profitability), the company's many customers (with varying demands for service), and the interaction between price, promotion and the number of units sold. These and other factors will complicate the break-even analysis.

Bill French: Case 16-3

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References

1. http://mathslover.hubpages.com/hub/Breakeven-analysis 2. 3. 4. 5. 6. 7. Press. pp. 312. ISBN 978-0-521-87928-6. Levine, David; Michele Boldrin (2008-09-07). Against intellectual monopoly. Cambridge University http://www.accounting4management.com/Break_even_analysis.htm http://www.accounting4management.com/Break_even_analysis.htm#WljKgF4s7uRSV5rO.99 (Dayananda, et al, 2002). (Harvard Business School, 1987).