2.3 Break-Even Analysis
If I do my calculations and find that I need to sell 25,000 pizzas a month in order to Break-Even, probably not a very good business idea. A lot of times you can take a cost that's variable, and throw it into fixed, coz, it's easier that way. Cuz a lot of times my, my system tracks how much money I've sold, but it's not necessarily telling me how many pizzas.
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Okay, so we’ve spoken about the the ways that we allocate cost here. And now I’m gonna show you one of the primary uses for cost allocation. And this is what we call Break-Even. Break-Even is a great word in business, we use it all the time. It means a few different things in a few different scenarios. And today we’re going to be talking about what I call an operational Break-Even. Okay so a Break-Even of the operating of business. We’re not talking about Break-Even in an investment or anything like that. Breaking-Even of a, of a companies performance okay. So we’re going to do a Break-Even analysis. And in calculating Break-Even, we’re gonna use the direct costs associated with producing an item. And what we want to know in calculating Break-Even is, let’s go back to the pizza example. How many pizzas do I need to sell in a calendar month, for example, to neither make money nor lose money? Where is my Break-Even? And this is vitally important to us, as you can imagine, for a, for a number of reasons. If you want to launch a new product. If you want to open a new a, a new, retail outlet, or a distribution outlet, or something. If you wanna start something new. What are you gonna have to do and is that realistic? If I do my calculations and find that I need to sell 25,000 pizzas a month in order to Break-Even, probably not a very good business idea. How am I gonna sell 25,000 pizzas a month? Can I even produce 25,000 pizzas a month? So, we’re gonna do Break-Even. And in Break-Even, we’re gonna look at fixed costs and variable costs, and we’re gonna divide these up. This can be a subjective division. A lot of times you can take a cost that’s variable, and throw it into fixed, coz, it’s easier that way. Or, take a cost that’s, that’s really, by nature, fixed. But we’re gonna make that variable, because it’s easier. Year that way. What’s important is that you’ve properly identified what your costs are. You need to know what your costs are. You’re not forgetting a cost. There’s not a cost out there that’s hidden, that’s not entering into your formula. Cuz that’s where you’re going to get into trouble. But once you know what your costs are. Then it’s pretty easy to determine. Do I wanna label this as fixed or variable? Is this a cost that I just kinda have to pay a flat fee, month after month after month, or is this something that’s really gonna change a lot with each pizza that’s ordered? Now, if we look at something, look at my gas bill. Right, my natural gas. I have a gas pizza oven okay. Well the more pizzas I bake, the more gas I’m likely to utilize. So my gas bill is really a variable cost to associated with the number of pizzas I produce. But that’s going to be a nightmare in accounting,. So, I’m gonna call my gas bill a fixed cost. That’s just the way I’m gonna do it. Okay. That’s gonna be much more relevant to me, applicable to my scenario. That’s gonna be an easier way to to, to categorize that cost. So, I’m gonna look at my my fixed costs and the first thing I need to do is I need to calculate my contribution of each item. In this case we’re talking about pizzas. So what do I mean by contribution? Well, I ha, I sell pizzas, and let’s say I sell my pizzas for ten dollars. So I sell my pizzas for ten dollars, and each pizza costs me three dollars and 60 cents. Okay that’s the variable cost for the pizza, that’s what I pay for the dough the cheese the pizza sauce the toppings. Three dollars sixty cents. Well this means that I have a contribution of $6.40 from each pizza. I sell it for $10, the direct cost is $3.60. So the contribution of the pizza is $6.40. So now I just take my fixed costs which were all the other costs that were not labeled variable. They didn’t go into the making of that pizza. My fixed costs need to be paid off. So what I do is I take my fixed cost, which in this example we’ll say is $4000 a month. $4000 a month covering my rent, covering utilities, covering my employees or employee, what ever it is, $4000. So if I. If I divide my contribution of $6.40, I’m sorry. If I, okay. So if I divide my fixed cost, $4,000.00, by my contribution, $6.40. I find that I have to sell 625 pizzas a month to Break-Even. Right? Because for each pizza I’m selling, $6.40 gets contributed to my, to my fixed costs. So once I’ve sold $625. All of my fixed costs have been covered. My variable costs are already covered because I’ve subtracted that to get my contribution. So, when I sell 626 pizzas, I have finally made $6.40 in profit. And for each pizza after that contribution becomes my profit. Now it’s very important for me to know the number of pizzas I need. And that’s what we call, that’s our standard Break-Even. Is the number of pizzas. The number of units I need to produce. The number of hours I need to bill. Okay. But, sometimes I also wanna know well what does that. What does that come to in terms of sales? Cuz a lot of times my, my system tracks how much money I’ve sold, but it’s not necessarily telling me how many pizzas. Well, that’s an easy one, too. So I need to sell 625 pizzas a month. I sell my pizzas at $10 each. Which means, I multiply those together. And I need to bill 600, $6,250 a month in pizza sales. So at $6,250 in sold pizzas per months. Per month, I’ve Broken-Even. Okay. I have not lost money. I have not gained money. At, $6260, the next pizza, I’ve made money. Okay? So this is Break-Even. And we have, an exercise for you on the platform that you can get into, and you can, calculate Break-Even yourself and work around, play around with it a little bit. And see how we use Break-Even and how we calculate Break-Even. Thank you. [BLANK AUDIO]
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