Suppose your business portfolio involves selling feed by the truckload. Assume you have determined that your fixed costs for this portion of your business are $1,500,000 and your variable costs are $21,000,000. You expect sales revenues of $23,400,000 for the year. So, the break-even calculation would be: Break-even sales = $1,500,000/2,400,000 /$23,400,000) = $14,625,000. Under these assumptions, the business must sell $14,625,000 of feed by the truckload to cover all costs, and then the remainder of sales generate a profit. If your business sells feed by the 25-ton truck at an average price of $180/ton, then you need to sell 3,250 truckloads of feed to meet break-even sales. Since you expect sales of $23,400,000 and break-even sales are $14,625,000, then sales above break-even are $8,775,000. If you look at the contribution margin as a percentage of sales (i.e. the denominator in the break-even formula — 2,400,000/$23,400,000 in our example), we see that roughly just over $0.1025 of every dollar of sales goes to cover fixed costs.
Including a profit goal
One thing you might want to do is target a specific level of profit for your feed and grain business. This is your profit goal. You can easily incorporate this goal into your break-even analysis to determine the sales needed to reach your target. The profit goal can be incorporated into the break-even formula as follows: Break-even sales ($) = (fixed costs + profit goal)/(contribution margin/total sales).
Let’s say that you have a profit objective of $900,000. The calculation then becomes: Break-even sales = ($1,500,000 + $900,000)/(2,400,000/$23,400,000) = $23,400,000. Notice that sales to reach break-even and make a profit of $900,000 are the $23,400,000 of sales that you estimated for the year. Thus, if your sales expectations and fixed and variable cost assumptions are correct, your business will have a profit of $900,000 this year. If you want to make a profit of over $900,000, then you will need to generate more sales than you originally estimated. Also, notice that you could determine the profit in our original example by multiplying sales above break-even by the contribution margin as a percentage of sales ratio, $8,775,000 x (2,400,000/$23,400,000) = $900,000.
After you have determined a break-even point, you can now evaluate a number of different scenarios using the calculation. This is often referred to as a sensitivity analysis and allows you to ask and evaluate a number of “what if” questions. For example, what if you increase your sales price by 25%, or what if your unit sales decline by 25% (these are just a couple examples). These “what if” questions can be quickly answered if you set up a simple break-even calculator in a spreadsheet; this will perform your calculations very quickly and will allow you to look at a number of different situations. The table below illustrates several different scenarios.
Note how increasing sales price and reducing variable costs have the greatest impact on increasing profit, assuming nothing else changes.
Your turn now
Using break-even analysis in your feed and grain business can help you understand and examine the profit drivers of your business. It is a very useful tool that can help you understand how much you need to sell to cover your costs and how pricing, cost and volume changes impact these needed sales. Start by gathering your financial data, classifying your costs and examining your sales. Try creating a spreadsheet with many formulas and developing realistic changes that you might expect during the next year or two in your business. If done correctly, break-even analysis will help you think through business strategies and generate valuable information for your business decision making.
Editor’s Note: This article originally ran in the August/September 2008 issue of Feed & Grain. Since it has been trending as one of the most popular articles on the website, we made the decision to rerun the piece.
Dr. John Foltz is interim dean, College of Agricultural and Life Sciences, and professor, Department of Agricultural Economics and Rural Sociology, University of Idaho, Moscow, ID. Dr. Christine Wilson is assistant dean, College of Agriculture, and associate professor, Department of Agricultural Economics, Kansas State University, Manhattan, KS.