In order to complete a break-even analysis we need to know all this data (Fixed Costs, Variable Costs, Sales Revenue). After completing this analysis we can easily state whether the business managed to get a profit or a loss.
To break-even Headliners Hair Salon have to sale 1,667 units where all costs are going to be covered. However, to make this clearer I am going to demonstrate a graph.
There is a formula to work out break-even:
Break-even point = Fixed Costs
Contribution (Sales Revenue – Variable Costs)
Using Appendix 1 I have calculated break-even point:
Break-even point = 10,000
15 – 9
Break-even point = 10,000
6
Break-even point = 1,667 Units
The main advantages of calculation are that is more accurate than a graph and it can be worked out in few minutes. I have completed the graph using the figures from Appendix 1 and this is a visulation aid for understanding break-even.
Now, I am going to consider the effects on the break-even point if there are any changes on costs or sales revenue which may incur at Headliners Hair Salon.
Using the formula I am going to calculate break-even point.
BEP = Fixed Costs
Contribution
What effect would the following changes have on break-even?
- An increase in direct material costs to £3.00 per unit
BEP = 10,000
15 – 9.5
BEP = 10,000
5.5
BEP = 1,819 units
Headliners Hair Salon would break-even at 1819 so the business would have to sell 152 units more if the direct material costs would increase to £3.00 per unit.
- A reduction in selling price to £14.00 per unit
BEP = 10,000
14 – 9
BEP = 10,000
5
BEP = 2,000 units
2,000 units need to be sold in order to break-even if there is a reduction in selling price to £14,00 per unit. The business would break-even slower if the price of the service is lower and it would have to sell 333 more units.
- An increase in fixed costs to £11.000 per annum
BEP = 11,000
15 – 9
BEP = 11,000
6
BEP = 1,834 units
The business would struggle to break-even if the expenditure is increasing. Headliners Hair Salon would have to sell 167 more units in order to break-even.
- A decrease in variable overheads to £0.75 per unit
BEP = 10,000
15 – 8,75
BEP = 10,000
6,25
BEP = 1,600 units
If the variable overheads are reduced to £0.75 per unit then the break-even point is 1600 units so this time the business is going to reach the break-even quicker. Headliners Hair Salon would break-even at 1600 units which is 67 units less.
If the costs are reduced the line of break-even would become stepper and the revenue would break-even quicker – this means that the business would improve their profitability.
Budgets
There are two main types of budgets which the business has to estimate each month; sales budget and expenditure.
Sales budget is the certain amount of the income from sales revenue. The business is usually sets a target and decides how many units they want to sell.
What will happen if the target is not met is that the business is going to increase the sales target for the next month.
This happens because if the business does not sell the estimated number of products it may not reach the break-even point.
Expenditure budget is the certain amount of money the business has planned to spend on a monthly basis. The business is estimating the level of costs.
Those two budgets are linked with each other – if the amount of sales budget increase, the same will happen to expenditure budget.
Costs indicate what budgets the business sets up; if the budget is not overspent it will increase the margin of profit.
The business has to consider few things such as stage of the economy, previous year sakes revenue, and the season before estimating the budgets. Each factor will have an impact on sales as well as on expenditure.
In order to estimate the costs, the business has to complete a variance analysis. This analysis needs to be completed at the end of each month and it is a main business tool to control finances.
The formula for the variance is:
Cumulative Budget – Actual Budget = Variance
The variance may be a surplus or a deficit, and it is the difference between the cumulative and the actual budget.
Also, there are two ways to set up the budgets when the business is planning monthly for each department.
Zero budget – The finances can be easily controlled if the business chooses to use zero budgets. Each department would have to ask the chairman if the money is needed in order to get the funds. Then, the chairman is going to decide whether the money can be spent or not.
Allocated budget – This budget is classified as allocated, when each department of the business gets different amount of money to spend on resources. This budget directly relates to the size of the department, the number of staff, and how much they have spent in previous year.
Now, I am going to look at Headliners Hair Salon cash flow.
Firstly, I would like to point out that there was an error in the calculations – the total income was £15000 and the expenditure was £13900 so there was a monthly surplus, not a deficit as stated. The accumulative surplus was then £2100, it is because the November had the sum of £1000 accumulative surplus which added up to £1100 it gives us the sum of £2100.
Headliners Hair Salon will struggle to break-even. The expenditure is too high, which makes the business hardly profitable. The budget is too low and it does not cover all the costs. This business should take some actions in order to avoid debts or even to avoid the bankruptcy.
Headliners Hair Salon should not increase the amount of wages paid out every month. Owners should wait until they have more funds and are easily breaking-even. Every business should also have a certain amount of money left over in order to cover any unplanned costs.
It may be worth trying to cut the costs and the increased number of sales is highly recommended. This would possibly help to make the business more successful. The owners of Headliners Hair Salon are supposed to control the cash flow forecast if they do not want the business to fall.
Firstly, the business should increase the number of sales to become more profitable.
In order to cut the costs Headliners Hair Salon should negotiate the rent payments with the landlord, so the fixed costs would possibly be reduced. The business may also change the power/gas supplier to save some funds.
