Effect on The Company’s Financial Statement if The Company was Not Operating At Break-Even
Which Part of The Financial Statement that Shows The Company Was Not Operating in Break-even
As the cost-volume-profit (CVP) analysis is a method for companies to determine how changes in costs (both variable and fixed) and sales volume affect the profit of a company, businesses can gain a better understanding of overall performance by examining how many units need to be sold to break even, meet a specific breakeven point, or maintain a safety margin (CFI Team, 2022).
Cost-volume-profit analysis analyzes the influence of variable costs on profit. Determining the break-even point for different sales volumes and cost structures helps managers make economic decisions (Kenton, 2022). Therefore, If a company’s CVP analysis shows that it is not working toward break-even, its net income will show a loss. Therefore, this can be seen in the annual profit line of the annual financial statements.
Now let’s see the concept of the calculation of CVP (BEP). According to Walther & Skousen (2009), 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. Therefore:
- Revenue = Total variable costs + Total fixed cost
- Contribution margin = Revenue — Total Variable Cost
- Contribution margin ratio = Contribution margin / Revenue
Walther & Skousen (2009) stated that when a company’s CVP ratio shows it’s not operating at breakeven, we can examine the impact on the Company’s financial statements, specifically on the operating expenses and the revenue part in the income statement and net cash provided by operations in the cash flow statement.
Hence, if a company doesn’t operate at a breakeven point, the operating expenses line in the income statement will be affected because the equation for this line is Profit = Total sales − Total variable costs − Total fixed costs. In addition, operating income is the money left over from sales proceeds after all operating expenses have been eliminated and before taxes have been paid. If a company is not working towards breakeven, this account would be zero or a negative value (Adkins, 2019). Adkins (2019) also added that Net cash is the balance of cash received from customers after deducting cash, interest, and taxes paid to suppliers and employees. If a company is not working towards breakeven, this account would likely be a negative value, similar to operating income.
Conclusion
When the income statement is not balanced, operating expenses, operating income and net cash are affected. The company will break even when its operating expenses are too high and its operating income is too low. This will affect the business, and it will go bankrupt or go out of business. That means the company foots the bill for its employees.
References
Adkins, W. (2019, March 1). What is the difference between operating & non-operating expenses? Small Business — Chron.com. Retrieved July 6, 2022, from https://smallbusiness.chron.com/difference-between-operating-nonoperating-expenses-39827.html
CFI Team. (2022, April 7). CVP Analysis Guide. Retrieved July 6, 2022, from https://corporatefinanceinstitute.com/resources/knowledge/finance/cvp-analysis-guide/
Kenton, W. (2022, February 7). Cost-volume-Profit (CVP) analysis definition. Investopedia. Retrieved July 6, 2022, from https://www.investopedia.com/terms/c/cost-volume-profit-analysis.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
