Scc2301 Ch2 l05 Breakeven

8/2/2019 Scc2301 Ch2 l05 Breakeven

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Break Even Analysis

Lecture 5

This lecture is part of Chapter2:

Budgets, Running aCompany


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Todays Lecture

Fixed versus Variable Costs

Break Even Analysis

Learn how to use the Solver in Excel


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Break-Even Analysis

An important part of running a company is the

determination of how the company should be

financed and how the prices of the products the

company sells should be set.

Clearly, in order to do this properly a sound

financial analysis is necessary.


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Types of costs

It is essential to realize that there are two basic types

of costs a company incurs.

Variable CostsFixed Costs

Variable costs are roughly proportional to a

companys sales. I.e. the cost per unit remains

roughly constant.

Fixed costs remain roughly the same regardless of

sales. I.e. the cost per unit is inversely proportional

to sales.


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Types of costs

Total Costs

Variable Costs

Fixed Costs

Sales

Sales Value

A simple graph but important to understand!


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Break-Even Analysis

Commonly, the Break-even point is defined to be

the level of sales where:

Revenues = Expenses

Let us have a look at a simple example.

Aunt Petunia opens a flower shop.


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Break-Even Analysis

Fixed Costs:

Rent: 5,000 Utilities: 300

Helper: 1,500

Variable Costs:

Flowers: 40% of selling price

So we know that:

Selling price cost of flowers rent utilities

helper = 0

when she breaks even


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Break Even Analysis

A B C D E F G H I

2

3

4

5

6 Sales Cost as percentage of

7 Cost of Sales 0 sales 40%

8 Rent 5000

9 Utilities 300

10 Helper 1500

11 Net Income -6800

12

Auntie Petunia Flowers - Break even Analysis

Lets enter the last line into the spread sheet

We learned something in the

last lesson. Its good to put the

assumptions separately.

=E6*$H$7But!!!?? Im not a

Mathematician!

How am I going to find the

value for E6 so that E11 = 0?

=E6-E7-E8-E9-E10


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Break Even Analysis

A B C D E F G H I

2

3

4

5

6 Sales 12600 Cost as percentage of


8 Rent 5000

9 Utilities 300

10 Helper 1500

11 Net Income 760

12


Piece of cake! Trial and error!

Oops! Not as easy as I thought.

Especially if H7 is not a nice

number like 40%. Is there a better way?


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The Solver

We could cave and write down the equation. That

would, in fact not be such a bad idea since equations are

really not as difficult to understand when one knows

what they are supposed to mean.

But *** RELIEF *** Excel has an incredibly useful

function called the solver. It will solve equations

without giving it the equations!

That was close .


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The Solver

The Solver can be found in the Tools menu of Excel. If

its not there, it can be installed by going to the Add-

ins menu item and selecting the Solver Add-in.

This is really quite self-

explanatory!

Enter the appropriatevalues for Set target

cell, Equal to and By

changing cells, and click

Solve.


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Break Even Analysis

A B C D E F G H I

2

3

4

5

6 Sales 11,333 Cost as percentage of

7 Cost of Sales 4,533 sales 40%

8 Rent 5,000

9 Utilities 300

10 Helper 1,500

11 Net Income 0

12


Let try out the Solver!

Incredible!

Like this anyone can do Math!

The break even

point is 11,333


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An Equation

The Solver is a fabulous tool, but really in business it is

beneficial to at least be open-minded about equations.

Lets give it a try! We know that:E11=E6-E7-E8-E9-E10

(Income = Sales Cost Rent Utilities Helper)

At the break even point, Net Income = 0 and hence E11

= 0

Inserting this we obtain:

0 = E6-E7-E8-E9-E10


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An Equation

We want to change E6 such that

0 = E6-E7-E8-E9-E10

is true.

Ah, if we just set E6 to the other values together the above

equation is true. Or,

E6 = E7+E8+E9+E10

is the solution to our problem.

Lets try it and go back to the situation before we used the

solver:


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Break Even Analysis

A B C D E F G H I

2

3

4

5

6 Sales 0 Cost as percentage of


8 Rent 5000

9 Utilities 300

10 Helper 1500

11 Net Income -6800

12


Lets fill the equation into cell E6

Oops!

What went wrong?

=E7+E8+E9+E10


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An Equation

May be Math isnt as easy as I thought

But wait, doesnt E7 depend on E6? Yes indeed, we have

defined E7 = E6 * H7 (cost of product).

Lets put this into our equation:

E6 = E7+E8+E9+E10 => E6 = E6*H7+E8+E9+E10

Or: E6 - E6*H7 = E8+E9+E10

E6 * (1 - H7) = E8+E9+E10

E6 = (E8+E9+E10) / (1 - H7)


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Break Even Analysis

A B C D E F G H I

2

3

4

5



8 Rent 5,000

9 Utilities 300

10 Helper 1,500

11 Net Income 0

12


Yosh! Lets try that again.

Yatta! It works

After all, this was quite easy wasnt it?

And now we can change H7 to play out

scenarios. Very useful indeed!

(E8+E9+E10) / (1 - H7)


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Break Even Analysis

A B C D E F G H I

2

3

4

5



8 Rent 5,000

9 Utilities 300

10Helper 1,500

11 Net Income 0

12


If Aunt Petunia raises the price so that the

cost is only 30% of sales .

she can break even already at 9714. Of

course now she may be so expensive that no

one wants to buy her flowers anymore.


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The other way around

There may be times when it is better

to turn things around.

Just now, Aunt Petunia found how much she needs to sellin order to break evengivencertain cost as percentage of

sales. This is in general a good idea since for many

products the profits are more or less set.

In order to see how feasible a business is one could also

enter an expected sales amount and then see how much the

cost of the product can be in order to break even.


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Break Even Analysis

A B C D E F G H I

2

34

5



8 Rent 5,000

9 Utilities 300

10 Helper 1,500

11 Net Income 0

12


With our nice equation, its fairly easy to

accomplish this:

E6 * (1 - H7) = E8+E9+E10

(1 H7) = (E8+E9+E10)/E6H7 = 1 - (E8+E9+E10)/E6

Cool! And I

thought that

FinancialAnalysis is only

for others


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Key Points of the Day

The Solver is a great tool

But Math can be very useful as well

There are two types of costs: Variable Costs

Fixed Costs

Break Even Analysis is a snap with Excel

Scc2301 Ch2 l05 Breakeven

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