BREAK-EVEN ANALYSIS

Classification of costs
Fixed costs
The hotel industry has a high proportion of fixed costs. Fixed costs are those which do not
respond to change in volume of sales. The highest percentage of fixed costs occur in case of the
room sales. Most of the expenses in a hotel are of the fixed nature. The percentage of fixed
costs in case of food and beverage operation is lower. Examples of fixed costs are, 1) rent,2)
interest,3) management salaries, 4) administrative and office expenses and 5) depreciations. All
such expenses accrue with the passage of time.
Variable costs
Variable costs are those that vary in proportion to sales volume. Food and beverage costs are
the best example of variable costs. When the volume of business increases by say 15%, there
is normally a 15% increase in food and beverage costs and vice versa.
Semi-variable costs
Semi variable costs are those that move in the same direction, but not quite in proportion of
the volume of sales. These costs are mixture of fully fixed and fully variable cost. Example of
semi fixed cost are : 1) the cost of telephone ( fixed rent and cost of calls), 2) heating costs, 3)
labour costs in seasonal hotels.
The high fixed costs and sales instability are the two most important factors determining the
operations and profitability in the hotel. Although a high proportion of total costs is fixed, some
costs like food and beverage costs are capable of being controlled. Control work will enhance
the efficiency, of management.
The purpose of food and beverage cost control is to keep the actual cost in line with what it
should be ( standard costs) without diminishing either the quality or the quantity of the
merchandise.
This, in turn, assures the highest possible gross profit for the operation. The main objective of
food and beverage cost control is to ensure that what is taking place is in accordance with the
objectives and policies of the hotel. On the basis of the profit objective of the hotel,
departmental profit target of the food and beverage department is established. Food facilities,
the type of customer, food quality standards, type and quality of service, the dcor, comfort and
atmosphere of the establishment need to be

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identified and defined. To be a profitable operation, the total costs per cent should never exceed
hundred percent. This could be expressed as follows:-Sales == Variable cost + Fixed cost+ profit
Or
Sales== Cost of sales+ Cost of labour+ Cost of overheads +/- Profit/Loss
The operation will always Endeavour to generate sufficient unit profit so that total of such unit
profits may cover fixed cost and result in an overall operating profit. In situation, when unit
profit is high fewer meals or/and drinks will have to be served to generate additional profits.
On the other hand low unit profit will force the restaurant to earn the same amount of profit by
selling greater number of units.
Breakeven point is a tool which an operation can use to utilize in its business. It tells when the
business starts to earn profit based on business estimated sales. It also tells, if the sales in a
restaurant are showing a declining trend, the management has to watch costs and reduce them
whenever possible. It tells to make every effort to promote sales more than normal.
Contribution
In an operation it is possible to determine sales volume needed to cover given fixed cost of unit
sales price and variable costs per unit is available for analysis. The difference between sales
value and marginal cost of sales (variable cost) is known as contribution margin. Each cover in
the restaurant is required to contribute to a fund which is the total of all fixed overheads, the
balance, if any, is the profit or loss. Mathematically, contribution may be expressed as follows:
Contribution = Fixed expenses + profit or Fixed expenses loss
Or Contribution = Selling price Marginal cost

BREAK-EVEN POINT:
The cost profit volume analysis is a means of showing the relationship between the factors
affecting profits. The point at which there is no profit or loss is designated as the breakeven
point. A business is said to be broken even when the total sales is equal to the total cost. It is the
point which serves as a base indicating how many units of products or rooms must be sold if a
company is to operate without loss. Each unit sold is expected to generate revenue in excess of
its variable cost and this earns a contribution towards the fixed cost and profit. As the profit is
zero at the breakeven point, the contribution margin is equal to the fixed costs. If the actual
number of sales is more than the break even volume, there will be profit
DETERMINING THE BREAK-EVEN POINT:
Changes in the volume of sales are not normally accompanied by corresponding change in the
profit. A simple method showing relationship between sales, cost and profit is to determine the
break even point by any of the following approach:

1. The formula approach

a) In units
b) In money value
c) As a percentage of estimated capacity
2. The chart approach.

Breakeven formula approach:

The breakeven point can be computed in terms of units of items or money value or sales volume
or as a percentage of estimated capacity.
a) Breakeven points in units:
The breakeven point may be calculated in terms of the number of units ( in covers, or beds or
rooms ) This point is reached when the units sold create sufficient revenue. To cover their total
costsboth fixed and variable. Each unit of covers/ bed/ room sold will cover its own variable
costs and leave a balance, the marginal contribution or income to cover the fixed costs. The stage
of breakeven point will occur when enough covers/ beds/rooms have been sold so that total
contribution is equal to the total fixed costs. The contribution per unit is the difference between
selling price per cover/bed/room and the variable cost per that cover/bed/room. The total
contribution is equal to unit contribution multiplied by units sold. The profit is calculated when
the fixed costs is subtracted from the total contribution. These may be expressed as
Unit contribution = Selling price per unit Variable cost per unit
Total contribution = Unit contribution * units sold
Profit = Total contribution Fixed cost

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The total costs at any volume equals to fixed component plus a variable component times the
number of unit of volume..
Y == F+Vx
Y == Total cost
F == Fixed cost
V == Variable cost
X == Volume of number of units.
Total revenue of any volume equals to the unit selling price times the number of units of volume
i.e.
Y == Px
Y == Total revenue
P == Unit selling price
X == Volume of number of units.
Therefore

Px == F+Vx

The breakeven point in terms of units can be computed by dividing the Fixed cost by
contribution per unit. Mathematically it may be expressed as

BEP (in units)

== F/S-V

Breakeven point
== Fixed cost
Selling price per unit marginal / variable cost per unit
BEP ( unit )

== Total Fixed expenses

Contribution

Selling price per unitVariable cost per unit== Contribution

It is necessary for a positive breakeven point to occur that the selling price be greater than the
variable cost per unit. If the selling price is less than the variable cost per unit, a negative sales
volume does exist, but the negative sales volume in practice is an unacceptable situation. In case
selling price is equal to the variable cost per unit no
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breakeven point can exist, unless the hotel has zero fixed costs. In situation where there is zero
fixed costs, every sales volume point will be a breakeven point, because revenue will be exactly
equal to total cost at any volume.
b) Breakeven point in terms of sales:
It can be simply explained as BEP in units x Selling price per unit
Or
Total Fixed cost x selling price per unit
Contribution
Or
Fixed cost
Contribution
Sales

Or

Fixed cost
contribution percentage

Contribution / Profit Volume Ratio or PV Ratio

The contribution is the difference between the sales value and the marginal cost of sales and is
sometimes referred to as gross margin. Each cover / bed / room is expected to contribute to a
fund which is the total of all fixed overheads, the balance if any is profit or loss. This
contribution will first go to meet the fixed expenses and then to earn profit.
Contribution may also be represented as
Contribution== Fixed expenses + /- profit/ loss
Or

selling price marginal cost

Or

Profit / loss == Contribution fixed expenses

The PV ratio is one of the most important ratio for studying the profitability of operation of a
hotel business. It establishes the relationship between the contribution and sales. Comparison of
PV ratio between the different dishes can be made to find out which one is more profitable.
Higher the PV ratio, more will be the profit and lower the PV ratio, lesser will be the profit.
Every hotel will like to increase the PV ratio by increasing selling

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price per cover, reducing the direct and variable costs and switching the preparation to more
profitable dishes showing more PV ratio.
When the variable costs ( per unit or total units) are divided by sales ( selling price or total ),
we get variable cost ratio. We derive the PV ratio on the marginal income or the contribution
ratio when the variable cost s subtracted from one.
PV ratio/ contribution ratio = 1 Variable Cost
Sales
Thus the PV ratio is, to be precise is nothing but a contribution to sales ( C /S ) percentage.
The PV ratio is usually expressed in terms of percentage with the help of the following
formula:
P/V ratio = Sales- variable cost x 100 Or S V x 100
Sales
S
Since profit at the BEP is zero dividing the fixed cost by the PV ratio gives the sales
volume that is necessary to recover the total foxed costs.
PV ratio is useful in the determination of the BEP and level output or sales to earn a desired
amount of profit. The ratio can also be used in the calculation of the variable costs and profit
for any volume of sales.
BEP ( sales ) ==
Fixed cost
P/V ratio or contribution ratio
Contribution may be defined as the excess of sales over the variable cost. Contribution margin is
therefore a surplus that is available to cover fixed costs and when fixed costs have been covered
as net profit. The excess of selling price over variable costs of sales is known as contribution or
contribution margin.
The contribution margin as a percentage of sales will depend on the cost structure of the
business. The higher the variable costs and lower the fixed costs, lower the contribution margin
and vice versa. As the hotel and restaurants operate at a very high percentage of fixed costs,
most of them have a high percentage of contribution margin in relation to their volume of sales.
Where the contribution margin is high changes in the volume of business will have a powerful
impact on the net profit. Once the fixed costs have been covered every increase in the
contribution margin is an addition to the profit.
The hotel sells three main products, accommodation, food and beverage. In case of room sales
the variable costs are very low in the range of 10 to 15 percent. The contribution margin in such
cases will be very high. In case of food and beverage sales

variable costs account for 30 to 50 percent of the sales volume. So the contribution margin
is about 50 to 70 %.
In case of cigars and tobacco the variable costs is very high, 80 to 90 %.and the contribution
margin is very less. An increase in sell of cigarettes and tobacco will bring about less net profit
than the room sales.
The contribution margin ratio is a percentage of the contribution margin. It is a common
method of measuring the impact of changes in the volume of sales on the net profit. Where the
contribution margin ratio is 60 % of each additional revenue, 40 % will be absorbed by variable
costs and 60 5 will be the addition to the net profit assuming of course that the BEP has already
reached.
Margin of safety =
The margin of safety is the excess of the actual sales or the budgeted sales over the breakeven
sales. The margin of safety indicates the extent to which sales may fall before the hotel suffers
loss. Larger the margin of safety, safer the firm. A high margin of safety is particularly important
in times of low occupancy. On the other hand if the margin of safety is small, a small reduction
in the sales or production will be a serious matter and lead to loss. A low margin of safety results
for a hotel which has a low PV ratio. Margin of safety is expressed in the following formula:
Margin of safety == Actual sales Breakeven sales
Or

Budgeted sales Breakeven sales

==
Profit
== Net margin
PV ratio
PV ratio

Margin of safety ratio== Actual sales Breakeven sales

Actual Sales
A low margin of safety may result for a restaurant which has a low PV ratio. When both the
MOS and PV ratio are low, the operation should think of the possibilities of improving these by
taking the following steps:
a)
b)
c)
d)

By increasing the selling price

Increasing the level of production
Reduce the variable cost and fixed cost or both
Substitute the existing menu by a profitable menu.

c) As a percentage of estimated capacity:

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Hotel and catering establishments are interested in computing the BEP as a percentage of the
estimated sales or capacity (covers / beds / rooms ). This could be achieved by dividing the
total covers / rooms by the breakeven room sales or cover sales. For example a hotel has a
estimated capacity of 500 rooms.( 182500 room nights ). Its breakeven point of 109500
room nights is achieved at an occupancy level of 60%. If the room rates are Rs 400
breakeven point of sales will be 4380000 at 60% occupancy. If the total marginal income
or contribution is available, the BEP as the percentage of estimated capacity could be
determined directly by the following formula:
BEP ( as a percentage of capacity ): ==

Fixed cost
Total Contribution

Breakeven chart approach:

A BEP chart is a device in graphic form designed to portray the principal sales- cost-profit
analysis of an operation. It shows for each level of activity the revenue, operating costs and
the resulting profit or loss. Sales volume is shown along X axis, and the cost and revenue
related to volumes are shown along the Y axis. The rate of occupancy or covers etc is
measured horizontally. The point of intersection of the total cost line with the revenue line is
the BEP. The area above this point is shown as the profit area and the area below this point as
the loss area . On the graph the margin of safety, which is the difference between BEP and
the actual sales can also be read.
The following steps are involved in constructing the breakeven chart:
1. Sales volume expressed in terms of amount or unit or rooms or occupancy percentage as plotted
on the X or the horizontal axis.
2. Revenue and fixed and variable costs are plotted on the Y axis.
3. A vertical line may be drawn on the right of the chart to complete the graph.
4. Different alternative breakeven chart can be drawn up.
In a simple graph fixed costs are represented by a horizontal line . The total cost of sales is
represented by the line above the fixed cost line. It moves upwards proportionately with
the volume. The sales revenue is represented the line moving upwards uniformly from the
origin of the axis.

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