Join Jim Stice for an in-depth discussion in this video Importance of breakeven analysis, part of Breakeven and Cost-Volume-Profit (CVP) Analysis.
- I hear that you like Thai food. You know, food from Thailand. - I love Thai food. Satay sticks, tom kha gai, pad Thai. Delicious. - Well, one of these days you'll have to take me out to Thai food sometime. Now let's think about the decision to open a Thai restaurant, and to make this more precise, let's consider whether it would make sense to open a Thai restaurant in our hometown of Grantsville, Utah. - [Voiceover] Ah, Grantsville. Population, according to the 2010 census, 8,893. Of course, there were just 3,000 people there when we were growing up.
- Okay, we'll say that there are about 9,000 people in Grantsville now. Let's consider the decision of opening a Thai restaurant there. What costs are there in operating a restaurant? Let's start with the fixed cost, the cost that will be there whether you have any customers or not. So the fixed cost. Okay, there's rent, insurance, interest on any money you borrowed to get the restaurant started, salary of the restaurant manager. You have to pay all of those fixed costs whether anybody comes to the restaurant or not. - [Voiceover] Good. Now, how about variable costs? These are the costs that go up the more business you have, the more people who come to the restaurant.
- [Voiceover] So variable cost. More customers means more cost for the food material, meat for the satay sticks, noodles for the pad Thai, coconut milk and lemongrass for the tom kha gai. Also, more customers means you have to hire more cooks and more servers. More customers means you use more electricity, more napkins, more of those little containers for the customers to take home some food. - Right. Those are the variable costs. Now here is the question. How many customers do you need to have each month in order to break even? Now, breakeven means that you don't make money, you don't lose money.
You take in just enough from sales from your customers to pay for all your expenses. - Well, see, I don't know. How would you figure out this breakeven number of customers? - Well, like this. First, you use your knowledge of selling prices and your variable costs to figure out how much you get to keep from each of your customers. - Okay, I see that. They pay me $10, but I have to immediately use some of that to pay my servers, to pay for my food, to my suppliers, and so forth. I don't get to keep the entire $10 selling price. - Exactly. So let's say that you get to keep, oh, $4 from that $10 selling price after you pay for your variable costs.
What you want is enough customers to come in, with you keeping $4 from each one, so that you can pay all of your fixed costs. Remember, those fixed costs are there whether you have any customers or not. - Okay, I've got it. Will I have enough customers, keeping $4 from each one of them, to be able to pay my fixed cost each month? - That's it. That is breakeven analysis.
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- Breaking down fixed and variable costs
- Pricing a service to cover costs
- Identifying high contribution margins
- Calculating a company's breakeven point
- Conducting breakeven analysis with breakeven equations
- Computing target net income
- Exploring sensitivity analysis