Agriculture Reference
In-Depth Information
Thus, for every dollar generated in sales, BF&G has 10.36 cents left to contribute to the
fi rm's overhead after variable costs have been paid. Thus, BF&G's contribution to overhead
or CTO is 10.36 cents or 10.36 percent.
The breakeven relationships essentially answer the question of how many unit
contributions at 10.36 cents per unit BF&G has to make before its overhead is paid. One
can think of overhead as a tank that must be fi lled over the operating period before
any profi ts are made. In our example, this fi xed cost tank has a constant capacity of
$1,149,722.
Step 4: calculate the breakeven point
The question is: How many units (dollars) of sales must there be, with each unit
contributing 10.36 cents toward the $1,149,722 overhead, to completely cover all
costs?
If BF&G opens its doors but sells nothing during the period, it incurs its fi xed costs of
$1,149,722, but has no revenue, so the entire $1,149,722 is a net loss. If they manage to sell
one unit ($100 per unit) of product, they incur the fi xed cost of $1,149,722 and the variable
cost of $89.64 for that unit. The total cost is $1,149,811.64 against an income of $100.00.
The loss is $1,149,711.64—pretty bad, but this loss is not as great as if they sold nothing.
The loss is reduced by $10.36 or 10.36 cents per dollar of sales. This represents BF&G's
contribution margin.
Conversely
,
if the selling price does not cover the variable cost of $89.64 per unit (i.e., the
selling price is $79.00), the loss per unit of sales would be $10.64 and the total loss from the
sale of one unit would be $1,149,732.64, which is greater than if they sold nothing. Hence,
the fi rm wants to produce as long as the selling price per unit is greater than the variable cost
per unit, which results in a positive contribution to overhead. If the selling price per unit does
not exceed the variable cost per unit, then the least-cost level of production for the fi rm is
zero units, and the amount of the loss is limited to the amount of the fi xed costs,
$1,149,722.
The obvious and critical question then is: How many times does this process need to be
repeated before the fi rm reaches the zero-loss point? Or, stated differently: What is the fi rm's
breakeven point? Each time another $100 unit is sold, its revenue is used fi rst to cover the
variable cost of $89.64. The remaining $10.36 is used to cover the fi xed cost or “overhead”
burden.
The CTO in any breakeven example may also be calculated as a percent of sales or in
dollars (cents) per unit. In these examples, CTO is assumed to be SP - VC (selling price
minus variable costs), in percent or dollars/unit. CTO may also be calculated as GM - VC
(gross margin minus variable costs), again, as a percent or in dollars per unit. Either approach
produces the same result since sales minus cost of goods sold equals gross margin. If varia-
ble costs are measured as a percent of sales, the breakeven amount is in sales dollars and is
calculated as shown below:
Fixed Costs
Breakeven in Sales Dollars
=
1.0
-
Variable Costs a
s a proportion of Net Sales
