Break even analysis: Break-even point is the point of sales resulting in no profit or loss. To determine this the cost has to be divided into variable coasts and fixed costs. Variable cost is the cost that changes with the change in volume. Fixed costs are the costs that do not change with the change in volume. The break-even point can be calculated by the sum of variable costs and fixed costs equalling it to the sales. The formula to calculate it is:
Let A= sales, VC= Variable costs, FC = Fixed Costs, B= Volume of sales in units, V= cost per unit variable, P = unit selling price then
A= VC+FC
PB=VB+FC
(P-V)B=FC
B = FC/ (P-V).
i.e. Break even sales in units= Fixed Costs
(Unit selling price – Cost per unit variable)
Example: A doors manufacturing company sells doors to house builders. Each door is sold at �30. The variable costs per door are �10 and the total fixed costs are �50,000. The break-even point can be calculated as:
B= FC/ (P-V) = 50,000/(30-10) = 2,500
So, 2,500 doors should be sold by the company to break even. ( Jae K Shim et al 2009; p.306).
Return on Sales (ROS): The basic goal of any business is to make profits. In business terms the word return is often used as a measure of profitability. This can be defined as the ratio of net income to net sales. Many companies work hard to get high return on sales. The high the rate of return on sales the higher will be the profit. The formula to calculate ROS is
Return on sales = net income
net sales
Examples: Palisades Furniture Company makes net income of $48,000 over the sales of $858,000 in the year 2005 when compared to the net income of $26,000 over the sales of $803,000 in the year 2004. Calculate the rate of return on sales?
2005
2004 Ind. avg
Rate of return on sales = net income = 48,000 = 0.056 26,000 = 0.032 0.008_____
net sales 858,000 803,000
This shows that the company’s return on sales is significant and is performing well than other companies in the same industry. (Charles T. Horngren et al. 2005; p.720).
Return on Assets (ROA): It is defined as the ratio of net operating profit after taxes (NOPAT) to the gross assets that are used in the project. The ROA value should always be high for any company. Most of the assets used in the project is the cash of the company. The net operating profit can be calculated as the gross sales minus the expenses and costs spent on the project. This gives us the net profit before taxes. To NOPAT can be obtained by subtracting the taxes paid from the net profit before taxes.
ROA= NOPAT
Gross assets
Example: Let us assume that a company is doing a project for a client. To do the project the client pays $ 3,000,000 to the company. The costs and expenses are $ 2,500,000 and the tax rate is 50percent of net operating profit and the assets used are $4,000,000. Calculate the ROA of the company?
Net operating profit before taxes = $3,000,000 – $2,500,000
= $500,000
Taxes= $250,000
NOPAT= $250,000
Return on Assets (ROA)=$250,000/$4,000,000
= 6.25%. (Michael W. Newell et al. 2004; p.75).