# Ch2Spreadsheetsuite - Setting Price Primer For those of you...

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Unformatted text preview: Setting Price Primer For those of you unfamiliar with break-even analysis here is a primer. Remember that costs come in two basic forms, fixed costs that are fixed and variable costs that vary with unit sales. The contribution margin per unit is computed in cell C29 by subtracting all of the variable costs/unit from the average selling price/unit. When this difference is negative, the more of the product or service the company sells the more it loses and bleeds to death. This is not a good economic model that never works! The alternative is a positive contribution margin where each sale contributes to a cash flow that pays for all of the fixed costs and when they are paid for contributes to profit How many sales do we have to make to cover all of our fixed costs? This sales volume is called break-even because when we cover all our fixed costs we are breaking-even which is an old fashioned term that decribes a state of affairs where a firm or a project does not lose money but also does not make any money, that is make a profit. Break-even sales volume is easy to calculate. To work out how many unit's contribution margins are needed to pay for all the fixed costs, you divide fixed costs by contribution margin. This is the number of units that need to be sold which when multiplied by the contribution margin per unit exactly equals fixed costs. Breakeven volume = Fixed Costs/Contribution margin = (C26/C29) = 236,667 Consider the following example. The following is a mini-spreadsheet to help you compute breakeven volume: Fixed costs \$71,000.00 Selling price/unit \$0.90 Variable cost/unit \$0.60 Contribution margin/unit \$0.30 Breakeven volume = Fixed Costs/Contribution margin = (C26/C29) = 236,667 Breakeven dollar sales = Break-even volume*Price = E31*C27 = \$213,000 Now you know why we stressed on learning what costs are fixed and what costs are variable and how important it is to measure them. If our fixed cost estimate is good, our variable cost/unit cost is good and our estimate of average price/unit is good then we can calculate how much we have to sell to recover the fixed costs involved in the strategy or project. We can then convert that amount into market-share and assess how feasible it is to achieve such market-share given the product distribution reach, proposed price and marketing mix campaign. In this way break-even analysis becomes a feasibility analysis. 1 But the goal of any project is not to break-even but to earn the shareholder required rate of return or profit. This needs to be added to fixed costs. Thus if we take the above example and add the requirement that the project should earn \$50,000. Then we now have: DuPont Financial Analysis (\$ in 000's) Management Accounting Information Inputs: Net Sales \$1,000 Inventory \$500 Cost of Goods Sold \$450 Accounts Receivable \$300 Variable Expenses \$150 Other current assets \$100 Fixed Expenses \$200 Fixed assets \$2,000 Total Liabilities \$800 Outputs: Income Statement Balance Sheet Assets Net Sales...
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Ch2Spreadsheetsuite - Setting Price Primer For those of you...

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