Money Talk: Break Even Analysis: A Metric for Everyday Use

Break even analysis is a fundamental and important criterion for management to use in formulating overall business strategies for selling printed product, establishing work shift production benchmarks, and evaluating success in various other areas of the company.

Performing break even analysis can help to:

• Determine price levels

• Analyze sales needs and goals

• Estimate whether or not an expansion project or cost-saving project makes sense, and more

The goal of a break even analysis is to determine when sales and revenue equal total expenses. Beneath the surface, the real value of this analysis lies in helping managers break down the components of the equation to determine the relationship between revenue, fixed costs, and variable costs. In essence, management should use it to determine answers to questions like:

• Has our press purchase paid off?

• Are we covering costs at our current pricing levels?

• Did our company break even on that big job requiring so many outside services?

• How much printing needs to be sold and produced so all of our expenses are covered?

Changing one component of the break even analysis changes the results and allows managers to explore various potential scenarios to make better decisions and forecasts.

 

Pricing Decision Break Even Analysis

Scenario: Here’s a snapshot of a company

 

Fixed Expenses (or exp. that act fixed) $/Month

Payroll and payroll taxes -$300,000

Benefits $ 15,000

Rent $ 35,000

Depreciation $ 25,000

Utilities $ 14,000

Factory expenses (insurance, maintenance) $ 91,000

Administrative (office, professional fees, etc.) $ 15,000

Selling expenses (travel, auto, entertainment) $ 30,000

Interest expense -$ 10,000

Total overhead or fixed expenses $535,000

 

The variable costs for the month based on $910,000 in sales look like this:

Variable Cost $/Month

Paper $185,000

Ink $19,000

Plates $15,000

Other $11,000

Outside services $96,000

Factory supplies $27,000

Sales commissions $52,000

Total variable cost $405,000

Sales for the month were $910,000. Fixed expenses (overhead) were $535,000. Variable expenses were $405,000. Did we break even?

In this scenario, break even looks like this: Sales = Fixed Costs + Variable Costs or $940,000 = $535,000 + $405,000. $910,000 is less than $940,000, so according to our figures, with sales of $910,000, the company lost $30,000 this month.

 

Cost Analysis: Evaluate the Components of the Equation

To find out what went wrong, we need to take a careful look at the equation, break it down, taking a careful look at costs and pricing. For this example, let’s assume fixed costs, or overhead, are tight and controlled. To perform an analysis of costs we turn to the PIA Ratios.

Upon research we find that our company’s variable costs as a percent of sales are high compared to industry profit leaders in the Ratios. Here are the facts:

Variable Cost $/Month % of Sales % of Sales for

Profit Leaders

Paper $185,000 20.3% 20.9%

Ink $19,000 2.1% 1.9%

Plates $15,000 1.6% 1.4%

Other $11,000 1.2% 3.1%

Outside Services $96,000 10.5% 8.5%

Factory Supplies $27,000 3.0% 1.8%

Sales Commissions $52,000 5.7% 4.1%

Totals $405,000 44.5% 41.7%

While taking a closer look at the components of break even, we determine that our variable costs seem to be about three percent higher than the variable costs of profit leaders. If we can control those costs, will we break even? Three percent seems like a small amount, but as a percent of sales it adds up. To bring variable sales down to 41 percent of sales, here’s the equation: 41% of $910,000 ($910,000 x 0.41 = $373,000). This means variable costs need to be reduced by $32,000. Suddenly, that three percent is a lot.

Can we shave $20,000 off outside services by doing more work inside and not sending it out? Can we reduce factory expenses by $10,000 by focusing on better purchasing and tighter usage?

In many cases, the answer is, “No, not really.” So in this scenario, the question becomes: What type of jobs can we do that do not require the use of outside services and this high level of factory expense? In other words, what kinds of jobs do we need sell to actually break even, and maybe even make money?

The answer might surprise you. Take a look at your past monthly performance. In months when break even was achieved, how did your ratios stack up to the industry profit leader performance? What was different in those months? Were particular cost components still out of line? If not, what did you do to achieve good ratios? Can good ratios be achieved in future months? If not, it might be a good time to look at those costs carefully and find solutions. We call it “right sizing”.

Unraveling costs and analyzing components can become a monumental task, especially when budgets are already tight. If it becomes too time consuming, get help.

 

Stuart Margolis, CPA and partner at MargolisBecker LLC, provides information that helps firms operate profitably. The company is the purveyor of the industry’s “Cash is King” and “Value-Added Principles of Management”, and compiles the annual Printing Industries of America Ratios, the industry’s premier financial benchmarking tool. More information at MyPRINTResource.com/10164246.

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