- Another illustration of a use of managerial accounting
is break-even analysis.
Let me explain this by the use of a real example
based on an experience my wife had.
My wife's name is Ramona,
and many years ago, back in 1985,
she was helping organize a charity banquet and a raffle.
The tickets to the banquet cost $250.
Pretty expensive.
It seems expensive now,
and it was real expensive back in 1985.
The tickets of the attendees were thrown into a container
at the end of the banquet
and the tickets were randomly mixed
and then one was pulled out.
The owner of the winning ticket won a brand-new car.
The car cost $18,000.
Now that doesn't sound like much,
but back in 1985,
that was a really nice car.
The other important cost was for the caterer,
who charged $40 per person for the banquet.
So let's review those three numbers.
People attending the charity banquet
paid $250 for each ticket.
The caterer is charging the charity $40
to give food to each person who comes.
In addition, the charity has to buy
a brand new car for $18,000.
Now I very carefully questioned Ramona
to make sure that I have all of the numbers correct.
After she had explained all the numbers to me,
I said to her,
well, Ramona, how many people need to come to this banquet
for you guys, the charity, to break even?
That was the question I asked Ramona,
and that's the question I'm asking you.
How many people have to come to this charity banquet
so they can avoid losing money?
Think about how you would compute that.
First we notice that the cost of the car is fixed.
It doesn't matter if one person comes to the charity banquet
or 3000 people come to the charity banquet.
The car is going to cost $18,000.
It's fixed.
There are lots of costs that are fixed in life.
If I've got a restaurant location,
the rent on my restaurant location is fixed.
It doesn't matter whether I sell 10 hamburgers
or 10,000 hamburgers.
My rent is the same.
And next, each person who comes
to the charity banquet pays $250.
Now, does the charity get to keep the whole $250?
No.
The charity has to give $40 to the caterer
for each person who comes.
The $40 per person is called a variable cost.
The amount of variable cost goes up
as more people come to the banquet.
In a restaurant,
a good example of variable cost is the cost of food.
The more people who eat at your restaurant,
the more money you have to spend on buying food.
So the people are paying you $250,
but for each person who comes,
you have to give $40 to the caterer,
so you only get to keep $210.
In managerial accounting,
we call this the contribution margin.
The contribution margin is the amount you get to keep
from each person.
In this case, the contribution margin per person is $210.
This is a very important number.
The break-even calculation comes down to this.
How many people need to buy tickets
with the charity keeping $210 from each ticket
to be able to pay the $18,000 fixed cost of the car?
$18,000 divided by the $210 per person
means that 86 people need to come to the banquet
in order for the charity to break even.
Break-even analysis is built on the idea
of separating your costs into those that are fixed,
the $18,000 for the car in this example,
and those that are variable,
the $40 per person catering cost.