A Case Study of Cvp Analysis Essay
A Case Study of Cvp Analysis
In order to compete with other milkshake shacks on the same beach of the resort, the small shake in my shack is priced at $5.00, a medium shake costs $7.00, and a large shake is priced at $10.00. My shack offers classic flavors of chocolate, strawberry and vanilla, but also caters to eclectic tastes with raspberry, mocha, Oreo shakes and many other different flavors. I use chocolate, strawberry and other flavored syrup to provide the flavor chosen by customers. The data for milkshake costs is base on the study of existing restaurants, industry reports and research on expected minimum costs to be incurred in operating the business. The cost of materials needed to make milkshakes is shown in table 1.
Table 1 Variable and Fixed costs to make milkshakes
Small (8oz.size)Medium (10oz.size)Large (12oz.size)
Whole milk ($15 for a 5 gallon=740oz.)2oz.2.5oz.3oz.
Cream ($20 for 1 gallon = 128oz.)2oz.2.5oz.3oz.
Sugar ($10 for a 15 lb.bag=30cups)1/4cups 1/2cups3/4cups
Flavored syrup ($13.5 for a 96oz. bottle )0.5oz.1oz.1.5oz. Vanilla ice cream ($24 for 600oz.)6oz.8oz.10oz.
Whipped cream ($2.50 for 6.5oz. can)0.15oz.0.2oz.0.25oz.
Straws 5” Color Flex Straws
0.05/piece6” Color Flex Straws
0.06/piece8” Color Flex Straws
Cups 8oz. cups
Shack rental $500/mo
Business insurance $600/yr Business license $25/mo
Milkshake blenders $700 for 10 blenders Refrigerator/freezer $500
Shack decoration (tables, counters, chairs, umbrella) $2400 Cleaning and equipment maintenance fee $150/mo Advertising (sign, banner, flyers) $ 125/mo
The total fixed costs shown in table 1 are $5075, which is the amount the owner is going to apply for a small business loan. This business loan assumes (i) a constant interest rate of 6% throughout the amortization period (2 years) and (ii) that interest payments will be made monthly for both payment types (Principal Plus Interest or Blended). For a $5075 loan amount, the monthly payment will be $224.93. The amortization table is shown in table 2 if the loan start date is Mar 2013:
Table 2: Amortization Table Loan
Besides the variable and fixed costs, and the loan payment mentioned above, I also assumed two part-time employees will be hired for my shack. Each of them will receive $10/hr and work 20 hours per week. The total labor costs will be $1600 which include taxes and benefits. The other cost for the business will be the 10% gross sales that will be given to resort where shack located.
2. Analysis assumptions
In order to finish the Cost-Volume-Profit analysis, several assumptions need to be made: 1)The sales prices for milkshakes in my shack are constant and competitive among other vendors. The costs of materials are assumed to be the minimum costs to be incurred in operating this business. 2)The depreciation periods for shack decoration (tables, chairs, counters, and umbrellas) are 3 years, and the depreciation periods for equipments (blenders, refrigerator and freezer) will be 5 years. 3)The business loan is a 2 years amortization loan; the monthly payment includes both principal and interest. 4)The mix of milkshakes sold will be: 30% small size, 40% medium size, and 30% large size.
3. Cost-Volume-Profit analysis
1) Break-Even Analysis
The break-even point is the level of sales at which the company’s profit is zero. The formula for the unit sales to attain break-even point is: Unit sales to break even= Fixed expenses/Unit CM
Based on the information of relative costs provided in part 1, we can derive the monthly fixed costs in table 3, and unit variable costs in table 4.
Table 3 Fixed monthly expenses
Expenses Amount Notes
Business insurance $50$600/12=$50
(blenders, refrigerator and freezer)$20$1200/60=$20
Shack decoration depreciation
(tables, chairs, counters, and umbrellas)$67$2400/36=$67
Cleaning and maintenance fee$150—
Advertising (banner, sign, flyers)$125—
Loan payment$224.93Table 2
Part time employees salary$1600—
Table 4 Unit Variable Costs
Expenses Unit priceSmall MediumLarge
Vanilla ice cream$0.04/oz$0.24$0.32$0.40
Knowing the monthly fixed costs and unit variable costs, we are able to calculate the Unit CM.
Small (30%)Medium (40%)Large (30%)
Sales price (a)……………………………………$5*0.9=$4.5$7*0.9=$6.3$10*0.9=$9 Variable expenses per unit (b)……………$1.26$1.72$2.18 Unit CM (a-b)*percentage………………0.9721.8312.046
The weighted Unit CM for milkshakes will be 4.85 (0.972+1.831+2.046). Using the formula for the unit sales to attain break-even point, my shack will need 570 cups of milkshakes to break-even ($2761.93/4.85). Among all of the sales, 171 cups are small size, 228 cups are medium size, and 171 cups are large. If I give myself a $3000 paycheck every month, it will increase the monthly fixed income to 5761.93 dollars. Hence, I will need to sell 1188 (5761.93/4.85)cups of milkshakes to break-even. Among all of the sales, 356 cups are small size, 476 cups are medium size, and 356 cups are large.
2) The Break-Even Chart
The relationships among revenue, cost, profit and volume are illustrated on a cost-volume-profit graph. A CVP graph highlights CVP relationships over wide ranges of activity. If 570 cups of milkshakes are sold, the total sales after subtracting the 10% for resort will be $3744.90 (171*5*0.9+228*7*0.9+171*10*0.9). Total variable costs will be $980.40 (1.26*171+1.72*228+2.18*171). Total fixed costs will be 2761.93, hence the profit is round up to be 0. If 1188 cups of milkshakes are sold, the total
sales after subtracting the 10% for resort will be $7804.80 (356*5*0.9+476*7*0.9+356*10*0.9). Total variable costs will be $2043.36 (1.26*356+1.72*476+2.18*356). Total fixed costs will be 5761.93, hence the profit is also rounded up to be 0. From the sales and costs data above, the break-even chart with and without owner’s salary is given in chart 1.
Chart 1 The break even chart
From chart 1, we can see that the total sales revenue and total expense lines in both graphs are with same slopes no matter owner’s salary is included or not. The only difference in two graphs is the fixed expense line shifts up by $3000 when the owner salary is included. It also makes the intercept of total sales revenue and total expense line in the second graph shifts up by $3000. The slopes keep the same. 4. Conclusion
From the CVP analysis above, I need to sell 570 cups of milkshakes in order to break-even. If I quit the job and pay myself $3000 per month to run the shack, 1188 cups of milkshakes need to be sold just to break-even. There are several factors that will affect my decision about quitting my job to open the shack. One of the greatest aspects of working for someone else is security. Running a shack might bring me more income during the tourist season, but I also need to take the risk that I will lose money when it is out of season. Working for my own business also means I need to give up some other benefits like a pension or company provided insurance. These are all the opportunity cost for leaving my job. By being a business owner, I would have to earn equal amount to make sure that money that has been lost is recovered in almost similar time frame. In order to do so, I will choose keep my current job and work part-time in the shack. Firstly, it will always make sure I have enough money to pay back the loan for the shack and keep business smooth even in the off season. Secondly, I can still guarantee the retirement plan for the long time, which is more financially smart. Last but not the least, by working part time in the shack, I don’t need to build in the whole pay check into fixed cost. Hence, the break-even point will be easier to reach. At the same time, as another part-time employee, I can help cut some labor cost or generate more sales revenue, in which way makes more profit for my business.