Break Even Analysis With Multiple Products -
Sales Mix:
Definition and Explanation of Sales
Mix:
The
term "sale mix" refers to the relative
proportion in which a company's products are sold.
The concept is to achieve the combination, that will
yield the greatest amount of profits. Most companies
have many products, and often these products are not
equally profitable. Hence, profits will depend to
some extent on the company's sales mix. Profits will
be greater if high margin rather than low margin
items make up a relatively large proportion of total
sales.
Changes in sales mix can cause interesting
variation in profits. A shift in sales mix from high
margin items to low margin items can cause profits
to decrease even though total sales may increase.
Conversely, a shift in sales mix from low margin
items to high margin items can cause reverse
effect-total profit may increase even though total
sales decrease. It is one thing to achieve a
particular sales volume; it is quite a different
thing to sell most profitable mix of products.
Sales Mix and Break Even Analysis:
If a
company sells multiple products, break even analysis
is somewhat more complex than discussed in the topic
break even point calculation. The reason is that
the different products will have different selling
prices, different costs, and different contribution
margins. Consequently, the break even point will
depend on the mix in which the various products are
sold.
Example:1
AB Company
|
|
Product A |
Product B |
Total |
Sales |
$20,000 |
100% |
80,000 |
100% |
100,000 |
100% |
Less Variable
expenses |
15,000 |
75% |
40,000 |
50% |
55,000 |
55% |
|
|
|
|
|
|
|
Contribution
margin |
5,000 |
25% |
40,000 |
50% |
45,000 |
45% |
Less fixed expenses |
|
|
|
|
27,000 |
|
|
|
|
|
|
|
|
Net operating
income |
|
|
|
|
18,000 |
|
|
|
|
|
|
|
|
Calculation of
break even point:
Fixed expenses
/ Overall contribution margin
27,000 / 0.45
$60,000 |
$60,000 sales represent the break even point for the
company as long as the sales mix does not changes.
If the sales mix changes, then the break even point
will also change. This is illustrated in example 2.
Example: 2
AB Company
|
|
Product A |
Product B |
Total
|
Sales |
80,000 |
100% |
20,000 |
100% |
100,000 |
100% |
Less variable
expenses |
60,000 |
75% |
10,000 |
50% |
70,000 |
70% |
|
|
|
|
|
|
|
Contribution
margin |
20,000 |
25% |
10,000 |
50% |
30,000 |
30% |
|
|
|
|
|
|
|
Fixed expenses |
|
|
|
|
27,000 |
|
|
|
|
|
|
|
|
Net operating
income |
|
|
|
|
3,000 |
|
|
|
|
|
|
|
|
Calculation of
break even point:
Fixed expenses
/ Overall contribution margin
$27,000 / 0.3
$90,000 |
Although sales have remained unchanged at $100,000,
the sales mix is exactly the reverse of what it was
in example1, with the bulk of sales now coming from
the less profitable product A. Notice that this
change in the sales mix has caused both the overall
contribution margin and total profits to drop
sharply. The overall contribution margin ratio (CM
ratio) has dropped from 45% to 30% and net operating
income has dropped from $18,000 to $3,000. The
company's break even point is no longer $60,000 in
sales. Since the company is now realizing less
contribution margin per dollar of sales, it takes
more sales to cover the same amount of fixed costs.
Thus the break even point has increased from $60,000
to $90,000 in sales per year.
Real Business
Example:
Roger
Maxwell grew up near a public course where
he learned the game and worked as a caddie.
After attending Oklahoma State on a golf
scholarship, he became a golf pro and
eventually rose to become vice president at
Marriot, responsible for Marriot's golf
courses in the United States. Sensing an
opportunity to serve a niche market, Maxwell
invested his life savings in opening his own
golf superstore, in Celebration of Golf (ICOG),
in Scottsdale, Arizona. Maxwell says, " I'd
rather sacrifice profit up front for
sizzle...[p]eople are bored by malls. They
are looking for something different."
Maxwell has designed his store to be a
museum-like Mecca for golfing fanatics. For
example, maintenance work is done in a
replica of a turn of the century club
maker's shop.
Maxwell's
approach seems to be working. In the second
year of operation, Maxwell projected a
profit of $81,000 on sales of $2.4 million
as follows:
|
Projected |
Percent of Sales |
Sales |
$2,400,000 |
100% |
Cost
of Sales |
1,496,000 |
62.33% |
Other
variable expenses |
296,000 |
12.33% |
|
|
|
Contribution margin |
608,000 |
25.33% |
Fixed
expenses |
527,000 |
|
|
|
|
Net
operating income |
$81,000 |
|
|
|
|
Happily for
Maxwell, sales for the year were even better
than expected - reaching $3.0 million. In
the absence of any other change, the net
income should have been approximately
$233,000, computed as follows:
|
Projected |
Percent of Sales |
Sales |
$3,000,000 |
100% |
Cost
of sales |
1,870,000 |
62.33% |
Other
variable expenses |
370,000 |
12.33% |
|
|
|
Contribution margin |
760,000 |
25.33% |
Fixed
expenses |
527,000 |
|
|
|
|
Net
operating income |
$233,000 |
|
|
|
|
|
|
|
However
net income for the year was actually
$289,000 - apparently because of favorable
shift in sales mix toward higher margin item.
A 25% increase in sales over the projections
at beginning of the year resulted in a 356%
increase in net income. That's leverage!
Source: Edward O. Welles, Going for the
Green," Inc., July 1996, pp.68-75. |
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