PROFIT MASTERY

Break-Even Evaluating Marketing Programs

Washington D.C.
July 25, 2014

Presented by
Steve LeFever, Chairman
Profit Mastery

Business Resource Services Inc. 200 First Avenue West Suite 301 Seattle, Washington 98119
Phone 206-284-5102

info@profitmastery.net

www.profitmastery.net


WhatGetsMeasured...GetsManaged

ProfitMastery

FinancialPerformanceisathreeleggedstool

Educationestablishingthefoundation

Benchmarkingcreatingtheyardstick

PerformanceGroupsprovidingthe
accountabilityanddiscipline

FinancialOperatingCycle

Net Profits

Cash Flow

Income Statement
Sales

Balance Sheet
Assets = Liabilities + Net Worth

Efficiency

Net Profit
Uses of Profits:
To pay for new assets
To pay off debt
To pay out to the owners

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SevenStepstoBusinessSuccess

1.Planproperlybeforestartup

2.Monitorfinancialposition

3.Understandtherelationshipbetween
price,volume,andcosts

4.Managecashflow

5.Managegrowth

6.Borrowproperly

7.Planfortransition

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IncomeStatementManagement
KnowingYourCosts

DEFINITION..........Managingtheincomestatementimpliesmanagingtherelationship
betweencosts,volumeandpricing.Breakevenanalysisisthetool
thatletsownersandmanagersgaugetheresultsofchangesincosts
orpricing.

REVIEW...............Wehavecompletedthesectiononfinancialstatementanalysis,
whichgivesusapictureofthepast.Withbreakevenanalysis,we
haveamethodtoanalyzethepresent.

IMPACT...............Breakevenanalysisfocusesattentionontwokindsofcostsfixed
costsandvariablecostsandhowchangesineitheraffectprofits.
Theanalysisanswersquestionssuchas:Willadecreaseinprice
producemoresales?

RESULTS..............Usingthebreakeventool,wewillbeabletorelatechangesincosts
and/orchangesinpricingtothecorrespondingchangesthatare
requiredinsalesvolumeifagivenlevelofprofitistobemaintained.

TheGoal:

Calculatingthesalesrequiredtoincurnoprofit,butno
lossandtoevaluatetheimpactofchangesincostson
thesellingpricecostvolumerelationship.

TheTools:

BreakEvenAnalysis
BreakEvenProofs
ExpansionAnalysis

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KeyTerms

BreakEven....................................... Tohavenoprofitandnoloss;thepointatwhichrevenues
exactlycoverexpenses.

VariableCosts.................................. Expensesthatvarydirectlywithsales;thosecoststhatare
incurredonlyifsalesaremade.

VariableCostPercentage................ Thepercentofeachdollarofsalesthatgoestocovervariable
costs.

FixedCosts....................................... Expensesthatdonotvarywithsales;thosecoststhatare
incurredwhetherornotanysalesaremade.

ContributionMargin........................ Theamountleftaftervariablecostsarepaid.Theamount
thatislefttocontributetocoveringfixedcosts(andprofits).

ContributionMarginPercentage.... Thepercentofeachdollarofsalesthatisleftafterthevariable
costpercentagehasbeendeducted;theamountfromeach
dollarofsalesthatiscontributedtocoverfixedcostsand
profits.

TargetProfit..................................... Theamountofprofitthatisplanned.Theprofitthatisaddedto
fixedcoststodeterminethesalesgoalsinrelationtoagiven
contributionmargin.

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BreakEven
(asexplainedbyyourcollegeprofessor)

Costs

Sales

BreakEven4StepProcess

1. Classifyexpensesasvariableorfixed

2. DetermineVariableCostPercentage

3. DetermineContributionMarginPercentage

4. CalculateBreakEvenindollars

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HowDoFixedCostsBehave?

HowDoVariableCostsBehave?

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UnderstandingContributionMargin

Sales

- COGS

- GrossProfit
- OE
NetProfit

Contribution
Margin

Sales
VC
WhatsLeft
FC
NetProfit

WithNetProfitat0,youareatBreakEven

WhatTypesofQuestions
CanBreakEvenAnswer?

1.

IfIcutoraddafixedcosthowwillitimpactthevolume
ofsalesIneedtoBreakEven?

2.

3.

IfIlowerpriceshowwillitimpactBreakEven?
IfIraisepriceshowwillitimpactBreakEven?

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StevesPenCompany

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TheCupTheory
TheConceptofContributionMargin

Sales

Contribution Margin
Variable
Cost
Cup

Fixed
Cost
Cup

Net
Profit
Cup

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TargetaProfit

Youwanttohaveaprofitof$200,000attheendofthe
fiscalyear.

Whatdoyouneedinincreasedsalestoinsurethislevel
ofprofit?

FixedCosts=$800,000(FC)

TargetedProfits=$200,000(TP)

TotalFC+TP=$1,000,000

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FourWaystoIncreaseProfits

Sales

Contribution Margin

Variable
Cost
Cup

Fixed
Cost
Cup

Net
Profit
Cup

1.
2.
3.
4.

Whatsthestrategicmanagementvalueofthispicture?

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BreakevenCaseStudyDollars
LakesPharmacy
PracticeExample

TwoyearsagoBradandRenwantedtofiguretheirbreakevensalesvolume,sotheywent
throughtheirmostrecentincomestatementandclassifiedandtotaledeachcategory.Here's
whattheygot:

VariableCost:..................$1,275,000
FixedCost:..........................$357,000

HisSaleswere:
Sales................................$1,700,000

1.

WhatwerebreakevensalesforLakes?Useyourbreakevenworksheettodothe
calculations.

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BreakevenCaseStudyDollars
LakesPharmacy
YouhavebeencalledintoprovidesomeassistancetoLakes.Theyhavealreadygonethrough
theirmostrecentincomestatementandclassifiedcostsintofixedandvariable.Hereiswhat
theycameupwith:

VariableCost:..................$1,986,700
FixedCost:..........................$490,800
Lakessaleswere:
Sales................................$2,500,000

Yourjobnowistocalculatetheirvariablecostpercentage,theircontributionmargin,andhis
breakevensalespoint;thenanswerthequestionsbelow.(Remember:Lakesmadeaprofitin
thatyeartheywerenotatbreakevensaleslastyear.)
1. WhatarebreakevensalesforLakesPharmacy?

2. Whatadditionalannualsalesareneededifrentincreasesby$2,000/month?

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BreakevenCaseStudyDollars
LakesPharmacy

3. You are planning a marketing program which will increase your FC by $2,500/month. What
additional annual sales will be needed to cover the cost of the program?

4. What total sales will be necessary to generate a $150,000 profit -- assuming that there
is no rent increase?

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BreakevenCaseStudyUnits
LakesPharmacy
Lakeshasahomogeneousunitprescriptionsthatcanbeusedtomeasureallproductsold.
WhatRenandBradneedtoknownowarehowmanyprescriptionstheyneedtosell.Hereis
thecostbreakdownperprescription:

SalesPrice(perprescriptions)..........$56.80/prescriptions
VariableCost(perprescriptions)......$43.50/prescriptions
FixedCost...................................................$490,800

1.

Howmanyprescriptionsmustbesoldtobreakeven?

2.

HowmanyprescriptionsmustbesoldbyanewPharmacist(whowillgetanannual
salaryof$95,000)tocovertheircost?

3.

Howmanyprescriptionsmustbesoldifthesellingpriceisraisedto$57.63per
prescriptionassumingthereisnonewsalespersonandnochangeinvariable
cost?

Whatifpricedecreasesto$55.37?

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ExpansionCase
LakesPharmacy
TheProfitMasteryprocessandtoolscombinedwithRenandBradsmarketingskillshave
themcontemplatinganotherstore.Thisstorewillbelocatedinanareasimilartothecurrent
location,andwheretheyhavenoticedthatthecompetitionisweak.Sotheypulledtogether
thefollowinginformationtohelphimmakethedecision:

ExpectedVariableCostPercentage..................76%

ExpectedFixedCosts.....................................$350,000

InvestmentinCurrentandFixedAssets...........$400,000

Minimumreturnoninvestment.......................20%

1. WhattotalsalesarenecessarytocovertheirfixedcostsandminimumROI?(Follow
thesesteps)

a.InvestmentxminimumROI=profitrequiredtoachieveROI

b.Fixedcosts+ROI=Totalcosttobecovered

c.100%variablecost%=ContributionMargin

d.TotalCost/CM%=SalesTarget

2.
HowmanycustomersmustLakesattracttothenewstoretobreakeven?
(Useyourstoresaveragedollarspurchasedpercustomer).

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PatientCareServicesCase
LakesPharmacy

RenandBradaretryingtodeterminehowtheyshouldpricetheirpatientcareservices.They
noticethatthecompetitionisweakinpatientcareservicesandareunsureifthirdpartieswill
reimburse.Sotheypulledtogetherthefollowinginformationtohelpthemmakethedecision:

Averagepharmacistspayperhour..............$40.00

Averagetechnicianpayperhour..................$16.00

Estimated%otheremployeecostperhour33%

Targetedgrossprofitmargin..........................24%

TargetedODP..................................................8.7%

1.
WhatisthetargetedpriceperhourReneandBradshouldchargeiftheyusea
pharmacisttoprovidethepatientcareservicesandtheydliketomakea24%gross
profitmargin?(Assumelaboristheonlycostofgoodssoldinthepatientcare
area.)

Dollars
Percentage
Sales

Less:AveragePayperhour

GrossProfitperhour

2.
WhatisthepharmaciststargetpriceperhouriftheyassumethePCSismarginal
revenue,andthereisnoneedtomakemorethantheirtargetedowners
discretionaryprofit(ODP)?

Dollars
Percentage
Sales

Less:AveragePayperhour

GrossProfitperhour

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3.

WhatisthetargetedpriceperhourReneandBradshouldchargeiftheyusea
techniciantoprovidethepatientcareservicesandtheydliketomakea24%gross
profitmargin?(Assumelaboristheonlycostofgoodssoldinthepatientcare
area.)

Dollars
Percentage
Sales

Less:AveragePayperhour

GrossProfitperhour

4.
WhatisthetechniciantargetpriceperhouriftheyassumethePCSismarginal
revenue,andthereisnoneedtomakemorethantheirtargetedowners
discretionaryprofit(ODP)?

Dollars
Percentage
Sales

Less:AveragePayperhour

GrossProfitperhour

5.
IfweassumethattheonlyvariablecostofPCSislaborandtheassignablefixedcost
forthespaceare$5,400,howmanyhoursmustbeworkedtocoverthefixedcost
ineachscenario?

24%GrossProfit
Pharmacists
Technicians
Salesperhour

VariableCostLaborper

hour
TotalVariableCostper

hour
ContributionMarginper

hour
BE=FC/CMperhour

8.7%ODP
Pharmacists
Technicians
Salesperhour

VariableCostlaborper

hour
TotalVariablecostsper

hour
ContributionMarginper

hour
BE=FC/CMperhour

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BreakEvenAnalysis

Breakevenanalysisidentifiesthatpointwhererevenuesexactlycovercostssothatnoprofit
isgenerated,butnolossisincurred.Asamanagementtool,itextendstoamuchbroader
application.Usingit,youcananswerquestionssuchas:

WhatadditionalsaleswillIneedtocovertherentincreasemylandlordis

proposing?

IfIraiseprices,howmuchcanmysalesdropbeforemyprofitsareaffected?

Ifsalesdrop(inarecession,forexample),howmuchdoIneedtocutfixedcoststo

maintainmycurrentlevelofprofit?

IfIcutmyprice,whatadditionalsaleswillIhavetomakeinordertomaintainmy

currentprofitlevel?

StepstoCalculateBreakEven

Step1

Classifyexpensesfromyourcurrentincomestatementintotwocostcategories:fixedor
variable.Thenaddupthetotalforeachcategory.

FixedCostsarethosethatremainconstantoverareasonablerangeofsales,ordonotvary
appreciablywithsalesvolume.Forexample:

Rent

OfficeSupplies

Advertising

Salaries

PayrollTaxes

Utilities

Depreciation

InterestExpense

Insurance

Whenthesedochange,theytendtojumpinincrementssuchasrentincreasesforadditional
space,depreciationonnewequipmentpurchases,orsalariesforadditionalstaff.Whenthis
typeofincreaseoccurs,breakevenneedstoberecalculated.

VariableCostsarethosethatvarydirectlyorproportionallytosales.Aneasywayto
evaluatewhetheracostisfixedorvariableistoask:dosalescausethiscost?Ifsalescause
thecost,it'svariable.Forexample:

DirectLabor

Commissions

DirectMaterials

BadDebts

Ifyoucan'tdecidewhattocallanexpense,beconservativeandcallitfixedthusmakingyour
breakevenpointhigher.

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Step2
Determinethevariableexpensepercentagethatis,thetotalvariableexpenseasa
percentageofsales:

VARIABLECOSTS=VARIABLECOSTPERCENTAGE
SALES

Step3
Determinethecontributionmarginthatis,theamountfromeachsalesdollarwhichisleft
afterdeductingvariablecoststocoverfixedcosts:

SALES%VARIABLECOST%=CONTRIBUTIONMARGIN%

Whichisthesamethingas:

100%VARIABLECOST%=CONTRIBUTIONMARGIN%

Step4
Calculatebreakevenusingoneofthetwofollowingformulas:

Tocalculatebreakevenindollars:

BREAKEVEN=FIXEDCOSTS
CONTRIBUTIONMARGIN%
NOTE:Expresscontributionmarginasadecimalnotapercentage.

Tocalculatebreakeveninunits(ifyourproductcanbemeasured
injustonetypeofunitsuchasyards,gallons,cases,orhours):

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BREAKEVEN=FIXEDCOSTS
SELLING
VARIABLE
PRICE
COST
PERUNIT
PERUNIT

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CostVolumeProfitRelationships
BreakEvenAnalysis:DollarBasis

Step1ClassifyYourCosts

Usingyourmostrecentincomestatements,classifyallcostsaseitherfixedorvariable,thentotaleachcategory.

ActualTotalSales =$_______________

TotalVariableCosts =$_______________

TotalFixedCosts =$_______________

Step2CalculateVariableCostPercent

Forevery$1.00ofsales,whatpercentgoesawaytovariablecosts.

$_______________=_____%

VariableCostPercentage=TotalVariableCosts=

ActualTotalSales
$

Step3CalculateContributionMargin

Forevery$1.00ofsales(afterpayingforvariablecosts),
whatpercentislefttocoverfixedcosts...plusanytargetedprofit?

100%VariableCostPercentage=100%_____%=_____%

Step4CalculateBreakEvenSales

Howmanycentsesdoesittaketocoveryourfixedcosts?

BreakEvenSales=TotalFixedCosts=$_______________=$_______________
ContributionMargin%%

NOTE:Tocalculatethesalesneededtogenerateatargetprofit,justaddthattargetprofitamounttoyour
fixedcosts,thendividethatamountbyyourcontributionmargin.

Step5CheckYourCalculations

Doesthesaleslevelyoufiguredactuallybreakevenorgiveyoutheprofitsyoutarget?

BreakEvenSales
_______________

minus VariableCosts*

_______________

equals ContributionDollars

= _______________

minus FixedCosts

_______________

equals NetProfit

= _______________

*ComputethisfigurebymultiplyingBreakEven(above)bytheVariableCostPercentinStep2.

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total

CostVolumeProfitRelationships
BreakEvenAnalysis:UnitBasis

Step1ClassifyYourCosts

Usingyourmostrecentincomestatements,classifyallcostsaseitherfixedorvariable,
thentotaleachcategory.Recordtheactualnumberofunitssoldandactualsalesvolume.

ActualTotalSales =$_______________

TotalVariableCosts =$_______________

TotalFixedCosts =$_______________

TotalUnitsSold =________________

Step2CalculateYourPricePerunit

PricePerUnit=TotalSales=$_______________perunit
NumberofUnitsSold

Step3CalculateYourVariableCostPerUnit

VariableCostPerUnit=TotalVariableCosts=$_______________perunit
TotalUnitsSold

Step4CalculateYourContributionDollarsPerUnit

PriceperUnitVariableCostperUnit

=$___________perunit$_________perunit=$_____________perunit

Step5CalculateYourBreakEvenSalesinUnits

BreakEvenSales=TotalFixedCosts
ContributionDollarsperUnit
= $_______________
$perunit

= __________unitsneededinsalestobreakeven

NOTE: Tocalculatethesalesneededtogenerateatargetprofit,justaddthattargetprofit
amounttoyourtotalfixedcosts,thendividethatamountbyyourcontributionmargin.

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