Revision Session

Break Even Analysis

Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").


The Break-Even Chart

In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:



In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.
Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.

Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs

Variable Costs

Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.

Semi-Variable Costs

Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.

Menu Engineering

https://pos.toasttab.com/blog/menu-engineering-menu-design

Menu engineering is a marketing oriented approach to the evaluation of a menu with regard to its present and future content, design and pricing. It is an interdisciplinary field of study devoted to the deliberate and strategic constructions of menus. It is also commonly referred to as menu psychology.

Menu engineering is a step-by-step process through which management can evaluate current and future menu pricing, design and content decisions identifying menu items for membership in 4 categories

The goal of menu engineering is to maximize profits by subconsciously encouraging customers to select the menu items that make the most money and steering them away from less profitable dishes 

Depending where an item occurs on the matrix, appropriate action should be taken

STARS (High POPULARITY & High PROFITABILITY):

Are profitable and popular items / leave them alone or perhaps consider raising their price

a bit. It is possible to increase their menu prices without affecting volume.

CASH COWS/PLOUGH HORSES (High Popularity & Low PROFITABILITY): 

Are relatively unprofitable but popular items / try to improve their individual contribution margins without decreasing volume. Optional actions are to increase price, reduce dish cost by modify the recipe, use less expensive ingredients, or reduce the portion size. Look for a way to keep them on the menu but increase their contribution margins without decreasing volume.

QUESTION MARKS/puzzles (High PROFITABILITY & Low Popularity): 

Are comparatively profitable but relatively unpopular items / keep them on the menu but try to improve popularity (volume) without substantially decreasing profitability. Optional actions include price reduction, the renaming of the dish, repositioning the item on menu, item promotion through staff selling, or removing it from menu.

DOGS (Low PROFITABILITY & Low Popularity):

These are items that are both unprofitable and unpopular, combining low volume and small contribution margin. These items need to be replaced. If they need to remain on the menu for some reason, alter them so that they move up to at least the QUESTION MARK classification. Optional actions include replacing the dish, redesign dish or removing it from menu. Remove from the menu unless there is a valid reason for continuing to sell them or profitability can somehow be increased.