Cost of project and break-even analysis

Cost of project • Land and Site Development: it includes basic cost of land, payable on leasehold, Cost of Leveling and Development, laying approach road and internal roads etc. • Building and civil work: it includes building for main plant and equipment, building for auxiliary services like steam supply, workshop, drainage, garage, laboratory and open yard facility etc. • Plant and machinery: includes in case of imported goods f.o.b(free on board) value + shipping + freight + insurance + import duty+ clearing+ loading etc. In case of indigenous goods it includes f.o.r (free on rail) value+ sales tax + octroi+ other taxes. Cost of store and spares Foundation and Installation charge.

• Technical know how and engineering fees: technical consultant helps in preparation of project report, choice of technology, selection of plant and machinery, detailed engineering and so on. • Expenses on foreign technician and training of Indian counterpart: Foreign technician are required for setting up project and supervising trial runs. Their travel, boarding, lodging and salary expenses are recorded here. • Miscellaneous fixed assets: those fixed assets which are not part of direct manufacturing like furniture, office machinery ,equipment ,tools etc.

• Preliminary and capital issue expenditure: Expenses incurred for identifying project, market survey ,feasibility report, drafting MOA and AOA, underwriting commission and fee to manager. • Pre operative expenses: Expenses like establishment, rent ,rate ,taxes ,travelling which are directly related to project implementation schedule. Financial institution provide for some delay (20- 25%) in schedule implementation and permit cushion in estimate. • Provision for contingency: This is to provide for unforeseen expenses & price increase due to normal inflation.

In order to estimate contingency we divide cost item into 1.firm, 2.Non firm cost item. Provide leverage of 5-10% for non firm items. • Margin money for working capital: is provided by commercial banks and creditors. A certain part of margin has to come from long term sources . The margin money is used to meet over run in capital costs. Financial institutions usually block out of loan amount an amount equal to margin money. • Initial cash loss: cash losses are normal for initial year. Failure to make such provision affect liquidity and impair operation.

BREAK EVEN ANALYSIS

Case let:

As an integrated beverage company, RefreshNow! leads its own brand design, marketing and sales efforts. In addition, the company owns the entire beverage supply chain, including production of concentrates, bottling and packaging, and distribution to retail outlets. RefreshNow! has a considerable number of brands across carbonated and non-carbonated drinks, 5 large bottling plants throughout the country and distribution agreement with most major retailer . RefreshNow! is evaluating the launch of a new product, a flavoured non-sparkling bottled water called O - Natura. The company expects this new beverage to capitalize on the recent trends towards healthconscious alternatives in the packaged goods market. RefreshNow! Vice President of marketing has asked to help analyse the major factors surrounding the launch of O – Natura and its own internal capabilities to the effort.

Question:

RefreshNow! has to decide whether to launch O – Natura, the team wants to understand the beverage market and consumer preferences to gauge potential success of O – Natura. The bottled market splits into non-sparkling, sparkling and imports. Flavoured water falls within non-sparkling. The team has gathered the following information on the country’s bottled water market. The information shows an estimate for the share of flavoured water, as well as the current share for the two main products: Cool and O2Flavor. Flavoured

Non –sparkling [100% = 8000 million gallons]

Cool

5%

Flavoured

20%

10%

O2Flavor Based on the target price and upfront fixed costs, what share of the flavoured non-sparkling bottled water would O – Natura need to capture in order to break even?

Here are some additional information to consider: O – Natura would launch in a 16oz.presentation(1/8 of a gallon) with a price of $ 2.00 to retailers. In order to launch O-Natura, RefreshNow! would need to incur $ 40 million as total fixed costs, including marketing expenses as well as increased costs across the production and distribution network. The VP of Operation estimates that each bottle would cost $ 1.90 to produce and deliver in the newly established process.

The break-even point is the point where the business sales have generated enough income to cover all of its fixed costs and expenses. Above that point, all of the business’s incoming revenue is profit as long as the expenses and costs are not increased and the sales amounts are not reduced. So, break-even analysis is a simple way to determine how much of the product must be sold to generate a specific level of profitability keeping the following in mind:  Each business has certain fixed costs that must be paid every month, whether or not any sales take place.  Each product or service has variable costs that are incurred when the product is produced and sold.  There are semi-variable costs that go up or down depending on the level of business activity.

There are several types of costs to consider when conducting a breakeven analysis, so here's a refresher on the most relevant. Fixed costs: Variable costs: Semi Variable Cost Setting a Price This is critical to our breakeven analysis; we can't calculate likely revenues if we don't know what the unit price will be. Unit price refers to the amount we plan to charge customers to buy a single unit of our product.

•Psychology of Pricing •Pricing Methods

Decisions The break-even point identifies the total amount of sales the business needs before profit can be earned. When analyzed closely, the break-even analysis also helps the business to identify excessive fixed costs. Since the break-even point is directly related to the fixed costs, reducing and controlling these costs aids the business in achieving a lower break-even point for quicker profitability.

ing Breakeven Point Formula When revenues exceed all of the expenses of an organization, then the company can begin to realize a profit. Many small business owners and managers worry about this point, the break-even point, prior to realization. After we identify our fixed and variable expenses, we can calculate the ing break-even point for our company.

ing Breakeven Point Formula(cont.) Before calculating the break-even point, we must first determine the contribution margin of each unit we sell. The Contribution Margin is the point at which the revenues exceed the variable expenses of the business, thus we calculate it by subtracting the total variable expenses from the revenues. We determine the company's Contribution Ratio by dividing the contribution margin by total revenues.

Finally, we calculate the Break-even Point by dividing the total fixed expenses of our business by the contribution ratio. If we are using annual amounts, then this is the point during the year where our expenses equal our revenues and our next rupee is profit.

Break even analysis is a widely used technique to study CVP relationship. Certain basic important are : 

Contribution : Excess of Selling Price over Variable Cost Contribution = Selling Price – Variable Cost = Fixed Price + Profit



Profit Volume Ratio ( P/V ratio): Establishes relationship between contribution and sales value. P/ V Ratio = Contribution / Sales = ( Sales – Variable Cost) / Sales



Break-even Point :It is the point which breaks the total cost and selling price evenly to show the level of output at which there shall be neither profit nor loss. Break-even Point ( Output) = Fixed Cost/ Contribution per unit Break-even Point ( Sales ) = Fixed Cost x Selling price per unit Contribution per unit = (Fixed Cost) / (P/V ratio)

Financial Breakeven Point Formula The financial break-even point is more personal than the ing break-even point and examines issues related to our personal finances. For every financial decision we make, there is a point when the benefits outweigh the costs associated with that decision. Some of the decision-making factors are subjective, unlike the ing break-even analysis. The financial break-even point is the point at which we should choose the option that we are deciding upon. One of the techniques is Payback Period.

Total Fixed cost = SC+(RC * T) Total Variable Cost = V *Q*T T = Payback Period in months SC = Startup cost RC =Recurring Fixed Cost P = Price per unit V =Variable cost per unit Q = No. of units sold per month

BEP In Of Capacity Utilization

Total Fixed Cost Total Contribution

X

Production in of % to installed capacity

Margin of Safety Margin of Safety = Total sales – Sales at Break Even Point Margin of Safety(Rs.) = Net profit / (P/V ratio) Margin of Safety (Ratio)=(MOS/Actual Sales)X100

Break-Even Point

Break Even Charts So, Break-even chart depict the level of activity at which there will be neither loss nor profit and also shows the profit or loss for various levels of activity. Forms of Break-even Chart :  Simple break-even chart : Depicts the quantity of production at which break even occurs.  Contribution break-even chart : Helps in ascertaining the amount of contribution at different levels of activity, besides the break-even point.  Profit chart : Depicts the profit at different levels of activity. The break even point is the point at which profit is zero.  Analytical break even chart : It is prepared to show different elements of cost and appropriation of profits.  Cash break-even chart : It is prepared to show the volume at which cash breaks even.

Solution: 1. Variable Profit per unit(VP) = $(2.00-1.90) = $ 0.10 Break Even Units = TFC/VP = $ 40 million/$0.10 = 400 million units 2. Non-sparkling flavoured bottled water market = 5%*8000 million gallons(MG) = 400 MG O – Natura sales in millions of gallons = 400 MG/8 units per G = 50 MG Market share = 50 MG/400 MG = 12.5% O- Natura would need to capture a 12.5% market share of flavoured non-sparkling bottled water in order to break even. Therefore, O- Natura would need to be the number 2 product in the market

Utility of CVP Analysis 

Fixation of Selling Price: The cost of the product and the desired profitability are two important factors which govern the fixation of selling price.



Maintaining a desired level of profit: In the face of price cuts, in case the demand for the company’s product is elastic, the minimum level of profit can be maintained by pushing up the sales. The volume of such sales can be found out by the marginal costing technique.



Accepting of price less than total cost: Sometimes prices have to be fixed below the total cost of the product. In such a scenario, a price less than the total cost but above the marginal cost may be acceptable because in such periods any material contribution towards recovery of fixed costs is acceptable rather than no contribution at all. 24

Utility of CVP Analysis ( Contd )



Decisions involving alternative choices: The technique of marginal costing helps in making decisions involving alternative choices ex. Discontinuance of a product line, changes of sales mix, make or buy, own or lease, expand or contract etc. The technique used is differential costing, which is an extension of the technique of marginal costing.

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Break Even Charts ( Contd ) Advantages of break even charts :  Provides detailed and clearly understandable information.  Profitability of products and business can be known.  Effect of changes in cost and selling price can be demonstrated.  Cost control can be demonstrated.  Economy and efficiency can be effected.  Forecasting and planning is possible. Limitations of break even charts:  Limited information can be presented in a single chart.  No necessity : There is no necessity of preparing break even charts because: -

Simple tabulation is sufficient Conclusive guidance is not provided No basis of comparative efficiency 26

Particulars

2007( Rs.)

2008(Rs.)

Differences(Rs.

Sales Total Cost Profit

32,20,000 29,80,000

34,50,000 31,40,000

2,30,000 1,60,000

2,40,000

3,10,000

70,000

Calculate : a)PV Ratio b)Annual Fixed Cost c)Fixed Cost to sales % Ratio d)BEP e)Margin of Safety Ratio

(a) P/V ratio = (Change in Profit/Change in Sales) x 100 (70,000/2,30,000) X100 = 30.43% 2007 2008 (b) Contribution (30.43% of Sales) Rs. 9,79,846 Less : profit (2,40,000) Fixed Cost 7,39,846 Annual Fixed Cost

(c ) (Fixed

Rs. 10,49,846 (3,10,000) 7,39,846

Rs. 7,39,846

Cost/Sales) X 100 = 22.98%(2007) = 21.45%(2008)

(d) BEP(Rs.) = Fixed Cost/ P/V Ratio = Rs. 24,31,305 (e) Margin of Safety = Sales – BE Sales Margin Safety ratio = (MOS/ Sales) X100 = 24.49%