Finance and Accounting for NonFinancial Managers: All the Basics You Need to Know by William G. Droms

Author:William G. Droms
Language: eng
Format: epub
Publisher: Basic Books

Thus, we can see that a selling price of $582.50 will yield the required profit. A simple computational check confirms that this is so:

BREAKEVEN CHARTS

Exhibit 8.1 presents a graphic representation of the breakeven problem posed by Peter Porter’s Porsche Plant. The horizontal line at $1,650 represents fixed costs (FC) and the upward-sloping line beginning at $1,650 represents total cost (TC), which is equal to the sum of fixed plus variable costs (VC). This line has a slope equal to $350—every unit increase in production results in a $350 increase in the total cost. The upward-sloping line beginning at the origin represents revenue (R) and has a slope of $500—every unit increase in sales produces a $500 increase in revenue. The distance between the revenue line and the total-cost line represents dollars of profit (above the breakeven point) or loss (below the breakeven point).

The graph is useful for two reasons. First, it illustrates the key assumptions of breakeven analysis discussed earlier. It clearly shows that revenue and total cost are treated as simple linear functions of the number of units produced and sold. Profit or loss is thus simply the difference between revenue and total cost, and the breakeven point occurs where revenue is exactly equal to total cost.

The second use of the graph is that it provides a simple visual interpretation of the effect of changing cost-volume-profit relationships. For example, it can be seen that the effect of incurring additional fixed costs is to shift the horizontal fixed-cost line upward, thus raising the total-cost line parallel to itself and causing the breakeven point to rise. The graph also illustrates the effect of “substituting” additional fixed costs (such as additional depreciation for improved capital equipment) for lower levels of variable cost (such as less direct labor and material waste). In this case the horizontal fixed-cost line will move upward but the total-cost line will become less steep due to lower levels of variable cost. The usual net effect of this process is that the firm will now operate at a higher breakeven level but will also have a higher contribution margin (revenue per unit less variable cost per unit). Thus, at levels of operation sufficiently above the breakeven point, profits are much higher, while near or below the breakeven, profits are less or losses are greater.

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