MA22 - Breakeven Point and CVP Analysis - Explained

Summary

In this module, the concept of Cost-Volume-Profit (CVP) analysis, also known as break-even analysis, is introduced as a powerful tool for assessing business ideas. The speaker illustrates the process through a real-life example of a friend's potential Airbnb business, focusing on estimating sales, variable costs, and fixed expenses. By calculating the break-even point and target profit, the speaker demonstrates how CVP analysis helps determine if a business idea is viable. The lesson emphasizes the importance of simple, yet essential numbers in making informed decisions for starting or growing a business.

Takeaways

• 😀 CVP (Cost-Volume-Profit) analysis is a powerful tool for assessing business ideas, especially when considering new ventures or making business decisions.
• 😀 Break-even analysis helps determine the point where a business's revenues equal its costs, without making any profit or loss.
• 😀 Understanding the components of CVP is essential: sales revenue, variable costs, and fixed costs are the primary elements to focus on.
• 😀 Contribution Margin (CM) per unit is a critical metric—it's the revenue left after subtracting variable costs, contributing to covering fixed costs and generating profit.
• 😀 In the case of the Airbnb example, the owner needed to rent out the property for 20 nights per month to break even, based on her fixed and variable costs.
• 😀 The break-even point doesn't include profit, it's simply the point at which revenue and expenses balance out, so aiming for break-even isn't a long-term goal for most businesses.
• 😀 To make a target profit, the number of nights to rent out needs to be recalculated, considering both fixed expenses and desired profit.
• 😀 In the Airbnb case, the initial target profit calculation (35 nights per month) revealed that the business model wasn’t viable without adjustments.
• 😀 CVP analysis encourages reviewing the underlying assumptions, such as pricing, costs, and capacity, to ensure the business model can meet goals.
• 😀 The process of CVP analysis can help identify if a business idea is feasible or if adjustments are needed to make it profitable in the long term.
• 😀 CVP analysis offers a simple yet powerful approach for new entrepreneurs to assess their business models and make informed decisions before investing too much time or money.

Q & A

What is the main purpose of Cost-Volume-Profit (CVP) analysis?

The main purpose of CVP analysis is to determine how many units or services a business needs to sell to cover its fixed and variable costs, as well as to achieve a target profit.

Why is CVP analysis also called break-even analysis?

CVP analysis is often referred to as break-even analysis because it helps determine the point at which a business's revenues equal its costs, meaning there is neither a profit nor a loss.

What are the key components needed to perform CVP analysis?

To perform CVP analysis, you need three key components: the sales revenue per unit, the variable costs per unit, and the fixed costs associated with running the business.

In the Airbnb example, what were the estimated sales revenue per customer?

The estimated sales revenue per customer in the Airbnb example was $150 per night.

What are variable costs, and what were the estimated variable costs in the Airbnb example?

Variable costs are costs that change with the number of units or customers. In the Airbnb example, the estimated variable costs were $50 per customer, which included Airbnb fees, credit card processing fees, cleaning, and other related costs.

What are fixed costs, and what were the fixed costs in the Airbnb example?

Fixed costs are costs that do not change with the number of units or customers, such as rent, mortgage interest, and property taxes. In the Airbnb example, the fixed costs were estimated to be $2,000 per month.

How do you calculate the contribution margin (CM) per unit?

The contribution margin per unit is calculated by subtracting the variable cost per unit from the sales revenue per unit. In the Airbnb example, the contribution margin was $150 (sales revenue) minus $50 (variable costs), which equals $100.

What does the break-even point represent?

The break-even point represents the number of units or services a business needs to sell in order to cover all of its fixed and variable costs, without making a profit or incurring a loss.

How did the Airbnb example calculate the break-even point in terms of customer nights?

In the Airbnb example, the break-even point was calculated by dividing the fixed costs ($2,000) by the contribution margin per unit ($100). This resulted in a break-even point of 20 nights per month.

Why did the friend reconsider the business model after calculating the target profit?

The friend reconsidered the business model because, based on the calculation, she would need to rent out the apartment for 35 nights per month to achieve her target profit of $1,500. Since there are not enough days in a month, the original model was not feasible, and adjustments to pricing, costs, or the property were necessary.