Transcript File
5-1 Capacity Planning CHAPTER 5 Break – Even Analysis Decisions 5-2 Capacity Planning Break-even analysis The break-even point is where total costs equal total revenue: in other words, no profit and no loss. The break-even point gives a business an initial target at which to aim. Like estimating - The quantity which must be produced and sold for a project to break-even (no gain, no loss) - The quantity which make specific profit - The price that should be targeted to make specific profit. 5-3 Capacity Planning To work out break-even we need to know The price you are charging The variable costs (direct costs) of each unit - these are the costs of raw materials, labour and so on. The fixed costs (or indirect costs/overheads) - these are the costs that stay the same whatever the level of output and will be things like rent, marketing costs, admin costs and so on. 5-4 Capacity Planning Cost-Volume Relationships Amount ($) Figure 5.5a Fixed cost (FC) 0 Q (volume in units) 5-5 Capacity Planning Cost-Volume Relationships Amount ($) Figure 5.5b 0 Q (volume in units) 5-6 Capacity Planning Amount ($) Cost-Volume Relationships 0 BEP units Q (volume in units) 5-7 Capacity Planning 5-8 Capacity Planning Worked example Dragon Shirts Ltd, a manufacturer of men’s shirts, has a maximum output of 70,000 shirts a year. Given that Selling price per sheet = $ 20 Variable cost per shirt = $ 10 Total fixed cost per year = $ 400,000 1- What is the profit margin per unit 2- Identify the break-even quantity 3- What is the quantity which should be sold to make £ $ 100, 000 profit 5-9 Capacity Planning 1- the profit margin per unit Shirts are sold for $ 20. The variable costs are $ 10. $ 20 - $ 10 = $ 10 Each shirt sold will provide £10 which can be used to cover fixed costs. Once fixed costs are covered each sale will contribute £10 towards profit. 5-10 Capacity Planning 2- The break-even quantity Q* = $ 400,000 $ 10 Total Fixed costs profit margin per unit (From answer 1) = 40,000 shirts 5-11 Capacity Planning 2- The break-even quantity When the company is selling 40,000 shirts, it will break-even (no profit, no loss). Sales revenue = 40,000 x $20 = $ 800,000 Total cost = FC 400,000 + VC ($10 x 40,000) = $ 800,000 Profit or Loss = Sales – Total cost = $ 800,000 – $ 800,000 = 0 5-12 Capacity Planning 3- We can use break-even analysis to find the sales required to reach a target level of profit Q target = Total Fixed costs + target profit profit margin per unit $ 400,000 + $ 100,000 = $ 10 50,000 shirts 5-13 Capacity Planning 1. 2. 3. 4. 5. 6. Make or Buy Available capacity Expertise Quality considerations Nature of demand Cost Risk Break-even analysis can be applied to make or buy decisions 5-14 Capacity Planning Make or Buy White Star Co. is introducing new product. If the company manufactures the product, the estimated fixed cost is $20,000 and the variable cost is $30/unit. When the company buys the same product, ready made, from a supplier, the estimated selling price is $80/unit. a) Should the company Make or buy the product? b) When the company is planning to sell 500 units of the new product, should they make or buy it?