Break-Even Analysis

Date:  2021-03-08 12:06:56
7 pages  (1790 words)
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This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
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This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Break-even analysis aims at establishing the minimum output that a firm must produce and sell to remain in business meaning that it will be able to fulfill all its obligations. Putting into consideration businesses like headliners, break-even analysis will only be complete after identifying both variable and fixed costs which will eventually lead to the amount of sales having catered for all the businesses expenses. Variable Production Costs:

Direct Materials = 2.50 / unit

Direct labor = 5.50 / unit

Variable overheads = 1 / unit

Selling price = 15 / unit

Fixed overheads to the new products = 10,000 / annum

The break-even point, i.e. the volume of sales for Headliners where there would be no profit or loss will therefore be;

Fixed Cost/ (Selling Price-Variable Cost)

10,000 / 15- (2.5+5.5+1) = 10,000 / 6

= 1,667 units.

This means that Headliners will earn profits after heating a target of 1,667 units sales volume.

Increasing the direct material cost by 0.5 will lead to,

Total variable cost = (3+5.5+1)

= 9.50

Break-even point will, therefore, change to,

10,000 / (15-9.5)

= 10,000 / 5.5

= 1819 units

We can, therefore, conclude that an increase in variable cost will lead to an increase in the break-even point hence, they are directly proportional to each other. In our case above, a 0.5 increase in total variable cost led to an increase in sales volume of 152 units. This shows that for the Headliners to realize profits in their business, they need to make more sales.

Reducing the selling price to 14 / unit will lead to;

Break-even point = 10,000 / (14-9)

= 2,000 Units

Holding the fixed cost and variable cost constant, a decrease in selling price from 15 to 14 would lead to an increase in the break-even point to 2,000 units. This means that reducing selling price by 1 will result to 333 units increase in the break-even point hence they are inversely proportional to each other. Increased sales volume will lead to profit making by the Headliners hence more products need to be sold.

Increasing fixed cost to 11000 / annum will lead to;

Break-even point = 11,000 / (15-9)

= 1834 Units

This means that holding both the variable cost and selling price constant, an increase in fixed cost from 10,000 to 11,000 would lead to an increase in the break-even point sales volume from 1667 units to 1834 units. That is, an increase in 1000 fixed cost will lead to 167 units increase in the break-even sales. This shows that fixed cost is directly proportional to the break-even sales volume.

A decrease in Variable cost from 1 to 0.75 will lead to;

Break-even point = 10,000 / (15-8.75)

= 1,600 units

Holding both the selling price and the fixed cost constant, a decreased in variable cost from 9 to 8.75 would lead to a decrease in the break-even sales volume from 1,667 units to 1,600 units. This means that decreasing total variable cost by 0.25 will lead to 667 units decrease in the break-even sales volume. The Headliners will, therefore, need to sell more products to increase their total variable cost which is directly proportional to break-even point sales volume which will eventually lead to increased profits.

Sales Budget

From the data provided above, we find that the predicted cumulative budget is higher in some months than the actual budget. The cumulative budget is composed of the sales and expenses of the Headliners business. This means that the business fails to meet the targets it sets at the beginning of each month, and this is possible on the basis that the business fails to maximize their sales.

This problem can be attributed to inadequate raw materials. For instance, the treatment products are not enough as shown in the table, yet the monthly purchases are correctly stated. Due to spending less than they had budgeted, Headliners revenue is not maximized. This can be improved by ensuring that there is always enough raw materials and products to increase the sales volume of the business hence an increase in total revenue.

BUDGET

A budget is an estimated amount of receipts and expenditure in a business for a specific period e.g. 1 year

Budgeting is important in that it helps businesses focus on their future performances and how they will fulfill their obligations.

Budget is the plan for the future. The different types of budget includes;

Cash budget This is the estimated amount of cash that flows out of the business

Sales budget These are the estimated sales expected to be made by the business

Expenses budget This is a prediction for future expenditure.

Production budgets This is a prediction of the amount of products to be made by the business.

Master budget This is the overall quantification of the budgeting plan that deals with the prediction of the future profit and loss accounts.

Costs involved in budgeting.

There are two types of cost that are involved in budgeting and these includes;

Fixed costs

Variable costs

Fixed costs are those costs that do not change regardless of the sales volume or the services offered by the business. These includes rent, salaries and insurance. The Headliners will, therefore, have to pay these costs regardless of whether they make profit or losses.

Variable costs are those expenses which change with the changes in the business performance. Increased performance can either lead to a positive change in the variable costs and vice versa.

There are two types of budgeting which includes;

Zero budgeting Here, the departments do not have budgets instead they ask for financial aid from the manager once the need arises throughout the year.

Allocated budgeting This is where a specific amount as stated in the budget is distributed amongst the different departments of the business and the respective employees in those departments.

Monitoring budgets and variances

Budgets are usually prepared at the beginning of the year and, therefore, the departments are required to follow them to avoid issues of overspending.

Monitoring the budget

If the sales made by the Headliners are more than the budgeted sales, this would be good news for the business but if the costs exceed the budgeted cost then it will be hard for the business to pay its expenses.

Variance analysis

This refers to the measure of the difference experienced between the budgeted performances in sales at the beginning of the year with the actual results in sales at the year end.

Monitoring the variances

This allows businesses such as the Headliners to identify any deviations in time and get them in order before they can cause problems. Terms such as favorable and adverse are used whereby favorable means that the results are better than the business had expected i.e. revenues are higher or costs are lower than thought. And adverse to mean that the revenues fell short of the expected results whereas costs are higher than expected.

Factors affecting monitoring and controlling budgets

Changes in consumer tastes. This leads to difficulties in predicting sales to be made by the organization. In order to avoid this, Headliners should aim at looking at the trends in consumer preferences and make hair according to the demand by customers. Overheads must be considered in order to have a correct future budget.

Changes in technology. This may affect the production. With the introduction of more efficient and reliable technology, production has greatly improved and; therefore, all the organization needs to do is to acquire and apply the new technology. All that the Headliners should do is to embrace the new technology and change their budget as well as production is expected to change. For instance, use of special type of shavers which are electrically powered reduces the time used during a haircut using scissors by more than half.

Increases in costs of raw materials- The enterprise in their budget should remember that should the price of raw materials increase, the overhead costs would be more expensive. This would compel the enterprise to re-prepare its budget or, at least, make major adjustments. While headliners need consider the fact that some treatment products' prices may be inflated, a condition that would cause the company to re-organize its budget plan.

Seasonal variations (moving verges)- Enterprises should predict their sales monthly since the trends may vary every month as the tastes and preferences of consumers are rarely static. In other words, the revenue an enterprise receives in one season rarely recurs. Revenue is mostly affected by the season. Thus, the business budget must be flexible, and the enterprise must ensure they have the best-suited budget for every month, and it should be perfectly flexible. For example, where Headliners expect to receive and serve more customers in September that they would in August since more students are likely to take a haircut before school because they would like to look more presentable in school.

Inflation (Price Indices) - Again, inflation is another factor that would cause Headliners or other businesses to reconsider their sales projections. This is because inflation would higher the price of products while the customers would still have the same purchasing power. This would be relevant to the business budget. In addition, in order to more accurately adjust the budget, Headliners would also have to consider the fact that the overheads on raw materials would be more costly before the inflation period. This can not be overlooked as it is one negative influence on the enterprise as its expenses would peak during the period. This must be reflected in their budget.

Performance and trends in previous accounting periods- the business will also need to apply ratio analysis. This would enable not only the organization to identify the overall organization performance in the current period, but also trends in preceding accounting periods. Headliners also need to be sure that things that negatively affect its performance in past periods do not recur. This is especially important because its recurrence would affect the budget and costs in a way that hurts the business. Further, they should avoid the assumption that history will repeat its self especially where the sales were above the normal sales by large margins. When they are able to contain situations that may run out of control, they are able to avoid unmonitored costs and budget which would cause them problems like:

Too high expenditures on materials and equipment thus surpass their budget. This would turn them inefficient or worse turn their profit to losses.

Misuse of savings- Headliners may in some cases spend less than they budgeted. These savings should be used to cover for other parts of the budget where the expenditure was underestimated. But if enough caution is not taken, headliners would not be able to use those savings to pay their debts.

In order to strengthen their financial status, as well as keep their expenditures within their budget, headliners use different methods of managing their resources and budget which include:

Managing budget and cost- This is the bidding with an aim to increase resources through the use of

Capital grants- This is the type of financing normally given to new businesses by the government. This is especially suitable for headliners. It will enable owners to have enough money for them to start operating the business in the market and bidding to increase futu...

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