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MODULE 4
Breakeven Analysis
4 Preview to ossigamit
A Questiong
Learning Objectives: .
m Understand
eakeven analysis
m Apply
eakeven analysis in new-project decision making
The classification of costs by their responses to changes in volume has applications in many deci-
sion-making contexts. The most prominent context, which is especially prevalent in the tradi-
tional manufacturing world, is
eakeven analysis. Public organizations also find
eakeven
analysis useful in making planning decisions related to new projects and programs.
[-] Definition of Breakeven Analysis
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Definition of Breakeven Analysis
Breakeven analysis is a method used to determine the volume or the number of products or ser-
vices that must be sold or in some other way reimbursed at a given price in order for the opera-
tion's total revenue to be exactly equal to its expenses. The service level at which this occurs is
called the
eakeven point, and it can be expressed in terms of unit sales or dollar sales. A vol-
4 A ume of sales or activities over and above the
eakeven point results in profit, and sales or activ-
° ities below the
eakeven point results in a loss.
nN Breakeven analysis is an excellent tool to use when planning out a new program. To make
sound financial decisions, financial managers in government and nonprofit organizations need to
know whether a proposed new program can
eak even given its projected activity volume and
cost structure. Conversely, financial managers may be required to answer questions about what
to do if the demand for an existing service is declining, for instance, as a result of the post-2008
economic recession. Nonprofits, specifically, may need to change the cost structure of their pro-
grams to compensate for reduced activity volume if their programs are to
eak even.
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. A Simple Equation
Mathematically, the
eakeven point can be derived by equating total revenues (TR) and total
costs (TC):
v4 TR=TC @ .
nN Total revenues and total costs in turn can be expressed as
TR=PxQ @)
and
TC=FC+Q x UVC, 3)
where
Pis the price,
A Q is the volume,
FC is the fixed cost, and
[-] UVC is the unit variable cost.
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PxQ=FC+QxUVC @
Solving equation 4 for
eakeven volume, one gets equation 5:
FC
Q=5——r ©)
vd pP-uve
Equation 5 indicates that the
eakeven volume can be calculated by dividing the difference
nN between price and the unit variable cost, also known as the contribution margin, into the fixed
cost of a program. As can be seen from the equation, the higher the fixed cost and the lower the
contribution margin, the higher the required volume for a program to
eak even.
Here is a simplified example of
eakeven analysis from the government services sector.
Assume a small town provides a swimming pool for its residents and charges $5 for daily admis-
sion. The variable costs for the pool are minimal: approximately $1 each day the pool is open to
cover chemicals, changing the water in the pool, and other items that vary with the level of pub-
lic usage of the pool. The management, maintenance, depreciation, and public safety costs total
approximately $100,000 for the season. Therefore, how many people must use the facility, paying
$5 each for daily admission, for the pool to
eak even?
To solve this problem, we can plug the fixed cost, admission fee, and unit variable cost into
. equation 5.
FC $100,000
pic Bos
=25,000
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are trying to determine how many tickets they will need to sell in order to
eak even. They esti-
mate their total fixed costs to be $400,000. The variable cost is $10 per ticket. If circus manage-
Vd 5 ment sets the ticket price at $60, how many tickets does the box office have to sell for the circus
| t 1. The Middlebury town council has invited the circus to come to town. The circus owners
to
eak even?
nN 2. Clifftown’s Parks and Recreation Department is introducing a new summer day camp fo
children in elementary school, providing programming from 8:00 a.m. to 5:00 p.m. Monday
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