Sale Mix and Break Even Analysis With Multiple Products


Sale Mix and Break Even Analysis With Multiple Products:

Learning Objectives:

  1. Calculate break even point when a company sells more than one product.

Sale mix–Definition and Explanation of the Concept:

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
=====

Computation / 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 below.

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

======

Computation / 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 marginand 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.

In Business | Benefiting from a Shift in Sales Mix: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.

You may also be interested in other articles from “cost volume profit relationship” chapter

  1. Contribution Margin and Basics of CVP Analysis
  2. Difference Between Gross Margin and Contribution Margin
  3. Cost Volume Profit (CVP) Relationship in Graphic Form
  4. Contribution Margin Ratio (CM Ratio)
  5. Importance of Contribution Margin
  6. Change in fixed cost and sales volume
  7. Change in variable cost and sales volume
  8. Change in fixed cost, sales price and sales volume
  9. Change in variable cost, fixed cost, and sales volume
  10. Change in regular sales price
  11. Break even point analysis (calculation of break-even point by contribution margin and equation method)
  12. Target profit analysis
  13. Margin of safety
  14. Sales Mix and Break Even with Multiple Products
  15. Cost Volume Profit (CVP) Consideration in Choosing a Cost Structure
  16. Operating Leverage and degree of operating leverage
  17. Assumptions of Cost Volume Profit (CVP) Analysis
  18. Limitations of Cost Volume Profit Analysis

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