3-Years Breakeven Analysis for a Parasailing Company

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Case Study: Parasailing Company

Fixed Cost & Variable Cost Categorization

Hayes (2022), stated that fixed costs refer to costs that do not change as the quantity of goods or services produced or sold increases or decreases. Fixed costs are expenses that a company must pay, regardless of any specific business activity. On the other hand, variable costs are business expenses that change in proportion to how much a company produces or sells (Kenton, 2022). Therefore we can categorize the provided data as follows:

• Sales price per flight $175, this will be accumulated at the end of the year
• Estimated loan payment per month $350, this will be categorized as a fixed cost since the company has to pay the same amount for each month no matter how many flights it has.
• Fuel costs per flight $100, this will be categorized as a variable cost since this cost will depend on the number of flights.
• Full-time scheduler salary $2,500 per month, this can be categorized as a fixed cost since the company has to pay the same amount salary each month no matter how many flights it has.
• Boat crew per flight $30, this will be categorized as a variable cost since this cost will depend on the number of flights.
• $500 per month dock fee and use of a small office on a pier, will be categorized as a fixed cost since this is an overhead cost that can be categorized under facility cost.

Total Fixed Cost/month (FC/month) = $350 + $2,500 + $500 = $3,350/month, therefore total Fixed Cost/year (FC/year) = 12*$3,350 = $40,200/year (see the detailed calculation on the Excel file attached to this assignment)

Total Variable Cost/month (VC/month) = $100 + $30 = $130/month, therefore total variable cost/year = 12*$130 = $1,560/year (VC/year) (see the detailed calculation on the Excel file attached to this assignment)

Year 1 Break-Even Quantity, Contribution Margin, And Contribution Margin Ratio Calculation

According to Walther & Skousen (2009), the Break-even result is when the number of sales is equal to the total costs. Therefore, the break-even point (BEP) is calculated by dividing the fixed cost of production by the unit price minus the variable cost of production. This is the production phase, where the cost of production equals the sales of a product (Mitchell, 2022). In order to calculate the Break-even quantity, the contribution margin and contribution margin ratio need to be determined.

The contribution margin is revenue minus variable costs. A contribution margin is a conceptual number that reflects the amount available from each sale after deducting all variable costs associated with the units sold (Walther & Skousen, 2009). Corporate Finance Institute (2022) defined Contribution margin as revenue minus all variable costs, divided by its revenue. It represents the marginal utility of producing one more unit. (see the detailed calculation on the Excel file attached to this assignment)

• Contribution margin/flight = Sales price/flight ($175) — Total VC/month ($130) = $45
• Contribution margin ratio = (CM ($45) / Sales price/flight ($175))*100% = 25.71%
• Break-even Flights/year = Total FC/year ($40,200)/CM ($45) = 893.33 = 894 flights (rounded)
• Break-even Flights/month = 893.33 flights / 12 month = 74.44 = 75 flights (rounded)

This means in order to break even we need to get 894 flights/year or 75 flights/month. With this number of flights, it is estimated that we can get an annual sales figure of $156,450.

Year 2 Break-Even Quantity, Break-Even Sales, And Contribution Margin Ratio Calculation

Start from this year we assume we will use sales referral cost which cost 2% of the overall sales. therefore, the calculation will be: (see the detailed calculation on the Excel file attached)

Total VC + Referral Cost per month = $130 + (0.02*175) = $133.5/month

• Contribution Margin/flight = Sales price/flight ($175) — Total VC + Referral cost/month ($133.5) = $41.5
• Contribution margin ratio = (CM ($41.5) / Sales price/flight ($175))*100% = 23.71%
• Break-even sales = Total FC/year ($40,200) / CM Ratio (23.71%) = $169,518.07
• Break-even Flights/year = Break-even sales ($169,518.07) / sales price per flight ($175) = 968.67 = 969 flights (rounded)
• Break-even Flights/month = 968.67 flights / 12 month = 80.72 = 81 flights (rounded)

Number Of Flights (Units) Needed To Retain A Profit Of $10,000 In Year 3

The target profit for year 3 is $10,000 therefore the calculation will be:

• FC/year + Target Profit = $40,200 + $10,000 = $50,200
• Number Of Flights (Units) Needed To Retain A Profit Of $10,000 In Year 3 =FC/year + Target Profit ($50,200) / CM ($41.5) = 1209.64 = 1210 flights (rounded)
• Break-even Flights/month = 1209.64 flights / 12 month = 100.80 = 101 flights (rounded)

Conclusion

Any limitations of the data, including what may be missing in this calculation are: the location, operational days hours (because this will relate to the number of possible flights), maximum number of flights, etc. Some limitations might be: inflation possibility, unit cost changes might happen in the future, and some changes might happen in the sales price. To summarize, I will recommend this company to take the loan since we just need 3–4 flights/day to break even and this is feasible in my point of view.

References

Corporate Finance Institute. (2022, March 5). Contribution Margin Ratio. Retrieved July 4, 2022, from https://corporatefinanceinstitute.com/resources/knowledge/finance/contribution-margin-ratio-formula/

Hayes, A. (2022, February 7). Fixed Cost. Investopedia. Retrieved July 4, 2022, from https://www.investopedia.com/terms/f/fixedcost.asp

Kenton, W. (2022, March 6). What is a variable cost? Investopedia. Retrieved July 4, 2022, from https://www.investopedia.com/terms/v/variablecost.asp

Mitchell, C. (2022, March 2). Breakeven Point (BEP) Definition. Investopedia. Retrieved July 4, 2022, from https://www.investopedia.com/terms/b/breakevenpoint.asp

Walther, L. M. & Skousen, C.J. (2009). Managerial and Cost Accounting. https://library.ku.ac.ke/wp-content/downloads/2011/08/Bookboon/Accounting/managerial-and-cost-accounting.pdf

Note:
This article is written based on University of The People Managerial Accounting (BUS 5110) written assignment by Fristy Tania in June 2022