Breakeven Point Calculations
Feb 06, 2014
Recently a client called with concerns about the possibility of dramatic changes in his sales volume. This was a manufacturing client that is relatively small and highly dependent on a very few number of customers. One of the customers had called and told him they were discontinuing several product lines that my client was solely responsible for manufacturing. Accordingly, he was faced with the possibility of losing what could be 30% of his volume or more.
He recognized immediately that such a loss would have a dramatic reduction on his profitability and may even affect his ability to stay in business. Accordingly, he was very concerned about his monthly breakeven point and asked that we make a computation to help determine what that might be. After we made the calculation, and provided him with the information, we had a more extended conversation about the real implications to him on the loss of this very significant amount of his volume.
The first item of note is that there is a huge component of his sales price represented by material purchases. As is true in many manufacturers today, the raw material represents 60% or more of the selling price so that if the volume was going to be reduced, 60% of that volume would also be reduced because they would no longer be required to buy that raw material.
What he was really losing was the portion of that sales price that represented the recovery of his overhead and his profitability. As we talked about that further it became evident that the breakeven point would indicate how much overhead he would have to remove to remain profitable with this much decreased volume.
In today’s business environment, many times the amount of fixed overhead that can be reduced is insufficient to make up the loss of volume particularly in the magnitude of 30% of existing sales. However in this case I believe there are reasonable expectations that he would be able to minimize his overhead in enough of a quantity to make up this difference.
That discussion got me thinking about all the possible uses of breakeven point. I think most businesses today view breakeven point as simply a rough gauge of where they should be aiming their sales at every month. However I have seen breakeven point used for many other purposes in the past that really became part of the day-to-day management of the company. Techniques for breakeven point include capital expenditure request justifications, analyzing relationship between fixed and variable costs and evaluating management efficiencies related to operational improvements.
As is true on so many management reporting issues, an accurate ledger prepared in a timely manner is key to the usefulness of a breakeven point analysis. We will devote future blogs to this topic of alternative uses for breakeven point calculations.
Categories: Cost Accounting