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Financial Modeling (UGB 317)

Block 1
1.0 Introduction of Break even analysis
1.1 Break-even analyses
Break-even analysis is all about the relationship of profits, cost, volume, and selling prices of the
product. Cost does mean fixed cost and variable cost; variable cost and revenue will be increase as the
volume of product increase. As in break-even analysis, as the name fixed cost, it will be fixed because no
matter how many product the company wanted to produce the cost of fixed assets such as machine,
vehicle, furniture as the tools for production and payroll as for the workers salary are necessary, even
there are no production in the month. At this point, break-even analysis will needed, due to the fixed cost
will be higher than variable cost and revenue at the starting point and profit will be made after the
company able to cover all the costs. The break-even analysis will assist company to locate the break-even
point, which is the point that located at when revenue is equals to fixed costs and variable costs. (Frank
and Alan, 2002)
Formula for Break-even point =
1.2 Break-even graph
Break-even analysis can be done in graph form as it will be easier to understand where and when
the company will start making profits. Below is the example of break-even graph.

Line A

Line B

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Financial Modeling (UGB 317)

When the revenue line crosses by total cost line, the crossing point are called break-even point
(BEP). This is the point where revenue and total cost are equal. At the crossing point it will linked to line
to sales axis and output volume axis, Line A and B. Line A which BEP linked to sales axis it shows the
break-even amount which is the actual sales and total cost are even. When BEP linked to Line B (output
volume axis) is shows the break-even quantity which is the actual volume of output is able to catch up
with total cost. The shading area called Profit area which is when revenue started to exceed total cost.
(Frank and Alan, 2002)
1.3 Advantages and disadvantages of Break-even analysis

Break-even analysis

Advantages
-Difference level of sales and
productions profit and losses
will be measures.
- Effect of changes in prices of
sales will be able to predict
-Relationship of fixed costs
and variable cost are able to
analysis

Disadvantages
- Only able to use for single
mix of product
-There will be time consuming
to prepare for break-even
graph.

2.0 Case Study for Break-even analysis (Appendix 1)


Pacific Food is an instant noodle factory which located in Bayan Lepas. Pacific Food produces
multiple flavors of Vege Lover, Chicken Soup flavor, Curry Soup flavor, Extra Spicy flavor, and Tom
Yam flavor. The verity choices of the product provided made Pacific Food make a stand in market share
of instant noodle. Pacific Food rent a factory which cost RM9, 500,000 per month to start their business,
due to the location is at Bayan Lepas industry area, the rental fees is quite high.
Pacific Food With a call-up capital of RM80, 000,000 and some machine cost RM 100,000,000.
Furniture and fitting cost RM28, 000 and 2 vehicles which cost RM 70,000 each. Pacific Food will use
break-even analysis to find out their factorys expenses can be covered and when will the profit begin.
Firstly, Pacific Food has set their retail price of 1 pack for each product, which is RM 0.80 for Vege
Lover, RM 0.90 for Chicken Soup flavor and Curry Soup flavor, RM1 for Extra Spicy flavor, and Tom
Yam flavor. As usual the instant noodle will be pack up with 5 packets in to 1 unit, and there will be 12
units in 1 carton. Pacific will sell it in carton unit. For the sales mix of the entire product, Vege Lover,
Chicken Soup flavor, Curry Soup flavor, Extra Spicy flavor, and Tom Yam flavor will be 15%, 25%,
20%, 25% and 15%. To get sales mix revenue, Pacific Food will be total up the entire product and
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Financial Modeling (UGB 317)

multiple with the sales mix, after that Pacific Food will needed to get average revenue which is by total
up all the sales mix revenue of difference product. RM 55.50 will be the average sales mix of Pacific
Food. Pacific Food confirmed the variable cost 1 pack is as below:
Variable Cost
per 1 packet
Mee
Seasoning

Vege Lover
RM
0.25
RM
0.05

Chicken Soup
RM
0.25
RM
0.05

RM
0.05
RM
0.05
RM
0.10
RM
0.50

packaging
carriage
Curry or Tom
Yam Paste
Other
material
Total

Curry

Extra Spicy Curry

Tom Yam

RM
0.25
RM
0.05

RM
0.25
RM
0.05

RM
0.25
RM
0.05

RM
0.05
RM
0.05

RM
0.05
RM
0.05

RM
0.05
RM
0.05

RM
0.05
RM
0.05

RM
0.10
RM
0.50

RM
0.05
RM
0.10
RM
0.55

RM
0.05
RM
0.10
RM
0.55

RM
0.05
RM
0.10
RM
0.55

The sales mix of 15%, 25%, 20%, 25% and 15% will also occupy. Pacific Food has to multiple
the variable costs with the total packaging product in 1 carton in order to get the variable cost in 1carton.
After that, Pacific Food will need to total up the entire product and multiple with sales mix percentage to
get total variable cost. After getting the total variable cost, to get average variable cost, sums up of all
difference variable cost are required. The average variable cost of Pacific Food is RM31.80.
In order to calculate total fixed cost, Pacific Food has defined the office suppliers, utilities and
salary. Pacific Food has already hired 2 administrations, 1 supervisor, 6 operators and 2 cleaner with
salary of RM 2, 000, RM 2, 800, RM1, 800, RM1, 000 each month. Next, the office supplies for every
month are RM 300 and the utilities are RM 4, 500 every month. The utilities of each month is high due to
machine usage is high. Pacific Food total fix costs are RM 385,600.
In Appendix 1 will show the break-even quantity and amount of Pacific Food is 16,270.04 and
RM902, 987.34. It means that Pacific Food have to get 16,270.04 carton of product order and must able
to get RM902, 987.34 to cover all the costs. With total of 30, 000 sales will made in a year, in Appendix 1,
shows that the maximum revenue is RM 1, 665, 000, while the maximum variable is RM 954, 000 and
the fixed cost is RM 385,600.

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Financial Modeling (UGB 317)

3.0 Sensitivity Analysis


3.1 Scenario 1(Appendix 2)
Pacific Food has decides to increase their product selling prices to 20% from the original case.
Total revenue and average revenue will be affected after the changes of selling price; the new average
revenue is RM 66.60. Since the changes are only done in selling prices, the fixed cost and variable cost
will remain the same. In Appendix 2, the graph shows that the break-even quantity and amount are
dropped compare to original case in Appendix 1; which is 11080.46 and RM 737, 958.62. For current
scenario, Pacific Food required to have at least 11080.46 orders and RM 737, 958.62 a year, only able to
start getting profit. After adding 20% of selling prices of entire product, the maximum revenue has
increase, which is RM1, 998, 000 and the maximize profit is RM 658, 400.
3.2 Scenario 2(Appendix 3)
Pacific Food was decided to produce more product which will able them to receive order of 4000
a month. But in order to overcome the overwhelming product order, Pacific Food has to hire more staff to
deal with it. Pacific Food has hire extra 1 admiration, 1 supervisor, 4 operators and 1 cleaner. There were
only changes in fixed cost, the average revenue and average variable cost will be remaining the same. As
in

Appendix

for

scenario

2,

the

total

fixed

cost

is

RM

517,

600.

Appendix 3 also shows that the break-even quantity and amount are become higher compare with the
original case in Appendix 1, which is 21839.66 and RM 1,212,101.27. In this case, Pacific Food required
21839.66 orders and generates RM 1, 212, 101.27 in a year to make sure this is even. As in Appendix 3,
due to sales number has increased, the maximum revenue and maximum variable are also increased in a
year, which is RM 2, 664, 000 and RM1, 526, 400. The maximize profit will be RM620, 000 which is
higher than original case.

4.0 Conclusion
Break-even analysis bring a clear picture to owner or management when they doing decision, as in
scenario 1, with only increase the selling prices of 20% will bring a maximize profit or RM 658,400
which is already double up the profit compare with original case. For scenario 2, to deal with the
overwhelming of product order, owner or management had to increase the worker, so the increase of
fixed cost, average revenue and average overhead are also able to gain profit, which the maximize profit
is RM 620, 000. As conclusion, owner or management will understand that scenario 1 will bring more
profit for them.
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