Break Even Analysis in 2 Easy Steps: Cost Volume Profit Analysis Break Even Analysis
Tutorial
Alright.
Welcome back again to MBAbullshit.com.
The topic for this video is “Cost Volume Profit Analysis” or CVP.
It is also sometimes referred to as “Break Even Analysis” or BEP for Break Even Point.
Alright, let’s get down to it.
Remember you can always go back to MBAbullshit.com.
So now, let’s try first to look for the breakeven point for business which is selling
only one type of product.
So we first have to do what we call “Break Even Point Analysis.”
This is a part or maybe even the first major fundamental part of “Cost Volume Profit
Analysis.”
So for example, your business sells watches at ten dollars each and it costs you three
dollars in variable costs to make each watch.
Now when you say variable cost, that might mean the plastic and the metal which goes
into each watch that you make.
Okay?
That’s just an example.
It cost you one hundred dollars per month in fixed costs to run your watch business.
So when we say fixed costs, an example might be the rent.
You have a flat fee of rent and maybe salaries of one hundred dollars per month for the storekeeper
and the rent.
And it doesn’t change even when you sell more watches or even when you sell less watches.
It’s always the same.
Unlike with the plastic and metal as your variable cost, if you sell more watches then
you also have to pay for more plastic and metal to make more watches.
If you sell less watches, then you have to pay for less plastic and metal to make the
watches.
So that’s why it’s called variable, meaning it changes a lot.
So now, if you sell twelve watches in one month, how much will your business earn or
how much will your business lose?
So to do that, we use this formula.
First, we look for the gross margin per watch, you’re selling it at ten dollars per watch
and it costs you a variable cost of three dollars to make each watch.
So you make a gross margin of seven dollars per watch.
Now notice that this gross margin is not yet your final profit.
Why is it not yet your final profit?
Because you still have to pay for your fixed cost such as rent and stuff like that.
So seven dollars per watch, okay?
You’re earning a gross margin of seven dollars per watch or a margin of seven dollars per
watch multiplied by twelve watches sold and you have a total gross margin for the month
or gross profit.
Some people called it “Gross Profit” but I find it confusing because it might be confused
with “File Profit”, so it’s better to use the word margin.
So you have the total of gross margin for the month of eighty four dollars.
Again, this is not yet your final profit, you have to subtract the fixed cost.
So, less the fixed cost of one hundred dollars per month, as you remember from the last slide,
and you make a loss of sixteen dollars.
Eighty four dollars minus one hundred dollars equals negative sixteen dollars.
It’s negative so that means you lose money.
So the important question is: How many watches do you need to sell so that you will not lose
any money?
So that you will at least break even.
So break even means if you’re selling enough so that you don’t lose any money.
So at breakeven you are not yet earning any money but you’re already not losing any
money anymore.
So how many watches do you need to sell?
So for that, you need to use this formula.
It looks like this.
The breakeven point in number of units equals your fixed costs divided by your selling price
minus your variable costs.
So it looks like this.
As you remember, the fixed cost is one hundred dollars a month and you divide that by your
selling price of ten dollars and then you subtract the three dollars in variable costs.
And you’ll come up with a number of one hundred dollars divided by seven dollars;
because this now is seven dollars.
And you’ll come up with the number of fourteen point twenty nine.
So you need to sell fourteen point twenty nine units or fourteen point twenty nine watches
in order to break even so that you do not lose any money.
However, remember that you cannot sell part of the watch.
You can sell fourteen watches but that’s not enough.
So you need to sell an additional point twenty nine watches.
But obviously you cannot sell point twenty nine watches.
You sell one watch or two watches or three watches.
So therefore, you must round it off to the higher number of fifteen units.
Okay?
So in regular math, you usually round off the amount to the nearer whole number.
So in this case, you might round it off to fourteen because it’s nearer to this than
fifteen.
However, in this case if you round it off to the lower number fourteen, you will still
lose money.
So, you always round it off to the higher number, fifteen units.
Okay?
So that is your breakeven point in number of units or in number of watches.
You need to sell fifteen watches in order to break even.
In this case, you would probably earn a small profit.
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