Case Study - Break-Even Analysis

Having received both the cash flow forecast (Feb Issue) and the financial

IMArchEsSuPErmIoRose nes become mich more sware and now nas

a more clear understanding of his tinancial statements

You may recall in the earlier case he was considering investing 27000 in a new childrens play area.

He has decided to partially fund this by long term finance from the bank.

small business advisor (bank emplovee has mentioned the concept of break-

The case now considers the factors that underpin this concent and its application to his accounts. He has recently received his draft profit and loss account for year ended 31 December 2005 and this shows-

Philip Rose Trading as White Swann Inn

Trading and Profit and Loss Account for the

Year Ended 31 December 2005

Sales

Stock at 1 January 2005

Add purchases

Less stock 31 December 2005

Cost of sales

Gross profit

Expenditure

Wages

Heat, light and power

Cleaning and maintenance

Consumables

Insurances

Rent

Business rates

Bank charges

Motor vehicle running costs

Depreciation

Fixtures and fittings

Kitchen equipment

Motor vehicles

Net profit for year

Includes maior re-decoration of bar area

15400

157150

172550

16100

325100

156450

168650

32100

8750

6500

1530

1350

28500

7650

800

1420

5000

1500

3125

98225

70425.

Break-Even

That point at which total contribution is equal to fixed cost and neither a profit nor loss is made.

The total fixed costs in many businesses tend to be high in relation to total cost and therefore a business must maintain a level of activity that not only contributes to covering fixed costs but provides an acceptable, or target level of profit.

To apply this technique to Philip's accounts we need to identify both the fixed and variable costs within the business.

This analysis is based on the accounts for year ended 31 December 2005.

After much discussion with Philip it was agreed that:

one third of the employee costs are variable (he has some core staff ie:

full-time barman - considered a fixed cost)

• 40% of the heat, light and power is variable
• one third of the motor vehicle running costs are fixed
• consumables are considered variable
• cost of sales is the true variable cost
• all other costs are considered fixed

ICB NEWSLETTER APRL BREAK EVEN ANALYSIS

Determine:

1. Separate the Fixed and Variable costs based on the assumptions above. Find the Fixed Costs and Variable cosy.
2. Determine the contribution margin and contribution margin ratio.
3. Determine the Break-Even point.
4. Show the break Even point graphically.
5. Determine Margin of safety