Apparel Industry Management

Apparel Industry Management 3(3+0)

Lesson 22 : Costing

Break-Even Analysis

Break-even analysis shows the amount of profit a firm would earn or lose with sales volumes above and below the break-even point. The break-even point is the point at which revenue equals expenses. At this point the firm does not earn a profit or incur a loss. Concepts of cost-volume-profit analysis as applied in break-even analysis may be applied to the business as a whole, specific divisions, seasonal lines or individual products. Break-even analysis can answer the "what- if' questions to determine the effects of pricing decisions, adding to non-variable costs, or substituting equipment for labor. It can be applied to sales, profit, cost, and selling price to resolve management issues such as expanding plant capacity, determining advertising plans, granting credit, and expanding production.

Calculation of the break-even point requires estimates of variable and non- variable costs and the price per unit. The break-even point can be determined by graphing the numbers or calculating,- the relationships. . Break-even analysis uses the contribution rate that is determined in direct costing to identify break-even volume. In a break-even graph, dollar values representing total revenues or total costs are on the vertical scale and the number of units sold is on the horizontal scale. Line A shows the relationship between volume and cost. Line B shows the relationship between volume and revenue. The difference between the lines is profit or loss at the volume indicated. At the point of intersection, total cost equals total revenue. This is the break-even point. Profits accrue only with volumes beyond the break-even point. Forecasted sales volume can be estimated and compared to profit goals.

The break-even analysis can be used to answer many cost-volume-profit questions:

1. What is the break-even volume at the established unit price?
2. What is the break-even volume if the price is increased or decreased?
3. What is the break-even volume for alternate methods of producing a product?
4. What is the break-even volume for the same product made "in-house" or by a contractor?

Break-even charting is one of the simplest means for a manufacturer to eval- uate and achieve positive cost-to-sales profit ratios. Once the break-even volume is determined it must be compared to marketing and sales projections to deter- mine whether a profitable volume is attainable. If the required sales volume is too high, then cost saving measures must be initiated if the style is to be retained in the line. A word of caution relative to break-even analysis. Two basic assumptions are fundamental tqbreak-even analysis: (1) any quantity can be sold at the same price, and (2) aveoge variable costs are constant per unit (McCarthy, 1978, p. 526). The implications of these assumptions must be kept in mind when applying the results of break-even analysis.

Prices for commodities and standardized goods such as precious metals are set by the impersonal market forces of supply and demand. Because apparel products are differentiated, there are few standardized goods in apparel markets. Apparel prices are set and administered by the firms who manufacture the products. Admin- istered prices are prices set or "administered' by the firms in the market rather than by impersonal market forces.