Andre has two situations, let us take a look at them:
- Each barber (Total 5 barbers) is paid $9.90 per hour and works 40 hours a week and 50 weeks in a year, regardless of the number of haircuts.
- The barbers receive $4 per hour plus $6 for each haircut.
In both the situations the following remain the same:
Situation 1:
Contribution Margin allows the company or an individual to determine the profitability of their service or product. To calculate the Contribution Margin we will have to subtract the Variable cost per hair cut form the Price of each Hair cut. The variable costs are the expenses that vary with the quality of the output. They differ in direct proportion with the quality.
Contribution Margin = Price per Hair cut – Variable Cost per hair cut
Break Even point is a situation of zero loss or profit. At this point the revenues of the business are equal to the costs incurred by the business. To reach the Annual Break Even Point we will have to divide Annual fixed cost by the Contribution Margin as shown below. The fixed cost would be the wages that Andre pays to his barbers and the rent. We will have to calculate the fixed cost before calculating the Annual Break even Point.
Annual Break Even Point = Annual Fixed Cost / Contribution Margin
Fixed cost is calculated as shown below:
Fixed Cost = Barber’s Wage + Annual Rent
Barber’s Wage = Number of Barbers * Hourly rate of payment * Number of hours worked by Barber
Annual Rent = Monthly Rent *No. of Months in a year
Operating Income of a business are its earnings before tax. For calculating the Annual Operating Income we will have to minus the Annual Cost from the Annual Earnings. We will get the Annual earnings when we multiply the number of haircuts in a year with the price of each hair cut.
Annual Operating Income = Annual Earning – Annual Cost
Annual Earning = Price of a hair cut * Number of hair cuts in a year
Annual cost = Fixed cost + Variable cost per client * Number of Haircuts in a year
Situation 2:
Contribution Margin is calculated by subtracting the Variable Cost per hair cut from the Price per hair cut. The price per hair cut remains the same as $12. However, the variable cost here differs from situation 1 as the payment structure changes in this situation. The barbers are now paid per haircut.
Contribution Margin = Price per Hair cut – Variable Cost per hair cut
Variable Cost Per Hair Cut = Shampoo cost per haircut + Payment to Barber (per haircut)
Fixed Cost = Barber’s Wage + Annual Rent
Barber’s Wage = Number of Barbers * Hourly rate of payment * Number of hours worked by Barber
Annual Rent = Monthly Rent *No. of Months in a year
Annual Break Even Point = Annual Fixed Cost / Contribution Margin
References
Wilkinson, Jim. (2013). Operating Income (EBIT). Retrieved From http://strategiccfo.com/wikicfo/operating-income-ebit/
Peavler, Rosemary. Fixed and Variable Costs. Retrieved From http://bizfinance.about.com/od/pricingyourproduct/qt/Fixed_Variable_Costs.htm
Jan, Irfanullah. Break – even Point Equation Method. Retrieved From http://accountingexplained.com/managerial/cvp-analysis/break-even-point-equation-method
