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Fixed costs
Fixed costs are also called overhead. These costs are always occur after the decision to start an
economic activity and they relate directly to the level of production, but not the quantity of production.
Fixed costs include (but are not limited to) depreciation of materials, interest costs, taxes and general
overhead costs (labour costs, energy costs, depreciation costs). A carpentry business that mainly makes
tables, chairs and closets, employs 50 people. The business has a large number of fixed costs. It’s about
costs that come back every month and stay the same, and can only change after a year. Think for
instance of salaries, monthly energy bills and the depreciation costs of current assets (including machines)
and fixed assets (such as a building).
Variable costs
Variable costs are costs that change in direct relation to the volume of production. This concerns for
instance selling costs, production costs, fuel and other costs that are directly related to the production of
goods or an investment in capital. For a carpentry business, mainly the costs for raw materials, auxiliary
materials, semi-finished goods such as wood, nails and copper handles, are variable. If they are producing
50 closets per month, they use less than when they produce 75 closets in some other month. Therefore,
these costs vary every month.
Financial Tool
The Break Even Analysis is a handy tool to decide if a company should or should not start producing and
selling a product. In addition, you can calculate the Break Even Point (BEP), also known as the critical
point. It is the turnover at which the total revenue would equal the total costs. In that case, the
organisation would break even and both the fixed and variable costs will be earned back. If the turnover is
lower than the total costs, it’s a loss. Everything over this critical point can be booked as profit.
Formula
In order to calculate the Break Even Point within the Break Even Analysis, you need certain data, namely
the fixed costs, the selling price of the product and the variable costs per product.
The Break Even Point is determined by the moment when the fixed costs have been earned back. That
only happens because of the so-called contribution margin; the selling price minus the variable costs.
When the fixed costs are divided by the contribution margin, you get the Break-Even Point.
Break Even Point = fixed costs / ( selling price – variable costs )
Algebra Method
Let X = BEP Peso Sales
X = FC + VC
X = P20,000 + ( P3/P4 X)
X = P20,000 + .75 X
X - .75X = P20,000
.25X = P20,000
X = P20,000/.25
X = P80,000
Using the preceding example where Total Fixed Costs amounted to P20,000;
the Variable Rate is P3, and Unit Selling Price is P4.
Algebra Method
Based on the data given in problem 1 calculate the following using algebraic method:
a. BEP Sales Volume b. BEP Peso Sales c. BEP volume with desired profit of P9,000
d. BEP Peso Sales with desired profit of P 9,000
Problem 2. Calculate using contribution method the break-even point in units (volume) and in sales
dollars , and prepare a CVP graph when sales price per unit is $35, variable cost per unit is $28 and total
fixed cost is $7,000.
If My people who are called by My name will humble themselves, and pray and seek My face, and turn
from their wicked ways,then I will hear from heaven, and will forgive their sin and heal their land.
- 2 Chronicles 7:14