Breakeven Analysis Part 1

Click here for Streaming Audio To Accompany Presentation (optional)

EGR 403 Capital Allocation Theory Dr. Phillip R. Rosenkrantz

Industrial & Manufacturing Engineering Department Cal Poly Pomona

EGR 403 - The Big Picture

Framework: Accounting & Breakeven Analysis Time-value of money concepts - Ch. 3, 4 Analysis methods
Ch. 5 - Present Worth Ch. 6 - Annual Worth Ch. 7, 8 - Rate of Return (incremental analysis) Ch. 9 - Benefit Cost Ratio & other techniques

Refining the analysis

Ch. 10, 11 - Depreciation & Taxes Ch. 12 - Replacement Analysis
EGR 403 - Cal Poly Pomona - SV3 2

Introduction
Break even (BE) analysis helps engineers understand the big picture Knowing how your project or assignment affects profitability can help you sell your projects to upper management Understanding BE analysis illustrates the value of engineers to the company
EGR 403 - Cal Poly Pomona - SV3 3

Recall from the P & L Statement

Fixed costs - do not vary (e.g., lease costs, rent, insurance) Variable costs - vary with volume of production (e.g., labor, materials, supplies, rent, etc.) Overhead can also be applied here as a variable expense or burden rate. Profit Equation Profit = Revenue - Expenses
EGR 403 - Cal Poly Pomona - SV3 4

Breakeven Volume
Total Variable Cost (VC) is a function of volume (x) of units sold. Total VC = Variable Cost/unit * x Total Cost = Fixed Cost + Total VC Revenue is also a function of units sold: Revenue = Price/unit * x Breakeven Volume is the number of units you need to sell so that: Revenue = Total Cost
EGR 403 - Cal Poly Pomona - SV3 5

Breakeven Volume (contd)

Find x such that: Price/unit * x = Fixed + VC/unit * x Therefore: xBE = Fixed Cost / (Price/unit - VC/unit) If actual volume is < xBE , you have a loss If actual volume is > xBE , you have a profit
EGR 403 - Cal Poly Pomona - SV3 6

Fixed Cost
Fixed cost is the the same, regardless of volume

EGR 403 - Cal Poly Pomona - SV3

Variable Cost + Fixed Cost

Total Cost goes up with volume because Variable Cost increases

EGR 403 - Cal Poly Pomona - SV3

Total Revenue is based on volume and selling price/unit. Where the Revenue and Total Cost lines intersect is the Break Even (BE) Point. That volume is the BE Volume

EGR 403 - Cal Poly Pomona - SV3

Profit
Above the BE point, the difference between the Revenue and Total Cost lines represents profit

EGR 403 - Cal Poly Pomona - SV3

10

Loss
If volume is below the BE point, the difference between the lines represents a loss

EGR 403 - Cal Poly Pomona - SV3

11

Break Even Analysis

Collect financial and cost information to determine fixed and variable costs
Fixed costs Variable cost/unit (labor, materials, overhead)

Estimate Selling Price per unit from marketing analysis and market testing Determine BE volume and compare to estimated sales If estimated sales volume is not above the BE volume, make adjustments
EGR 403 - Cal Poly Pomona - SV3 12