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Break Even Analysis With Multiple Products - Sales Mix:

Definition and Explanation of Sales Mix:

The term "sale mix" refers to the relative proportion in which a company's products are sold. The concept is to achieve the combination, that will yield the greatest amount of profits. Most companies have many products, and often these products are not equally profitable. Hence, profits will depend to some extent on the company's sales mix. Profits will be greater if high margin rather than low margin items make up a relatively large proportion of total sales.

Changes in sales mix can cause interesting variation in profits. A shift in sales mix from high margin items to low margin items can cause profits to decrease even though total sales may increase. Conversely, a shift in sales mix from low margin items to high margin items can cause reverse effect-total profit may increase even though total sales decrease. It is one thing to achieve a particular sales volume; it is quite a different thing to sell most profitable mix of products.

Sales Mix and Break Even Analysis:

If a company sells multiple products, break even analysis is somewhat more complex than discussed in the topic break even point calculation. The reason is that the different products will have different selling prices, different costs, and different contribution margins. Consequently, the break even point will depend on the mix in which the various products are sold.

Example:1

AB Company
 

Product A

Product B

Total

Sales $20,000 100% 80,000 100% 100,000 100%
Less Variable expenses 15,000 75% 40,000 50% 55,000 55%






Contribution margin 5,000 25% 40,000 50% 45,000 45%

Less fixed expenses

 

 

 

 

27,000
         
 
Net operating income 18,000

Calculation of break even point:

Fixed expenses / Overall contribution margin

27,000 / 0.45

$60,000

$60,000 sales represent the break even point for the company as long as the sales mix does not changes. If the sales mix changes, then the break even point will also change. This is illustrated in example 2.

Example: 2

AB Company
 

    Product A         Product B   

     Total    

Sales 80,000 100% 20,000 100% 100,000 100%
Less variable expenses 60,000 75% 10,000 50% 70,000 70%
 





Contribution margin 20,000 25% 10,000 50% 30,000 30%
 



 
Fixed expenses         27,000  

Net operating income 3,000

Calculation of break even point:

Fixed expenses / Overall contribution margin

$27,000 / 0.3

$90,000

Although sales have remained unchanged at $100,000, the sales mix is exactly the reverse of what it was in example1, with the bulk of sales now coming from the less profitable product A. Notice that this change in the sales mix has caused both the overall contribution margin and total profits to drop sharply. The overall contribution margin ratio (CM ratio) has dropped from 45% to 30% and net operating income has dropped from $18,000 to $3,000. The company's break even point is no longer $60,000 in sales. Since the company is now realizing less contribution margin per dollar of sales, it takes more sales to cover the same amount of fixed costs. Thus the break even point has increased from $60,000 to $90,000 in sales per year.
 

Real Business Example:

Roger Maxwell grew up near a public course where he learned the game and worked as a caddie. After attending Oklahoma State on a golf scholarship, he became a golf pro and eventually rose to become vice president at Marriot, responsible for Marriot's  golf courses in the United States. Sensing an opportunity to serve a niche market, Maxwell invested his life savings in opening his own golf superstore, in Celebration of Golf (ICOG), in Scottsdale, Arizona. Maxwell says, " I'd rather sacrifice profit up front for sizzle...[p]eople are bored by malls. They are looking for something different." Maxwell has designed his store to be a museum-like Mecca for golfing fanatics. For example, maintenance work is done in a replica of a turn of the century club maker's shop.

Maxwell's approach seems to be working. In the second year of operation, Maxwell projected a profit of $81,000 on sales of $2.4 million as follows:

  Projected Percent of Sales
Sales $2,400,000 100%
Cost of Sales 1,496,000 62.33%
Other variable expenses 296,000 12.33%
 

Contribution margin 608,000 25.33%
Fixed expenses 527,000
 
 
Net operating income $81,000  
 
 

Happily for Maxwell, sales for the year were even better than expected - reaching $3.0 million. In the absence of any other change, the net income should have been approximately $233,000, computed as follows:

  Projected Percent of Sales
Sales $3,000,000 100%
Cost of sales 1,870,000 62.33%
Other variable expenses 370,000 12.33%
 

Contribution margin 760,000 25.33%
Fixed expenses 527,000  
 
 
Net operating income $233,000  
 
 
     

However net income for the year was actually $289,000 - apparently because of favorable shift in sales mix toward higher margin item. A 25% increase in sales over the projections at beginning of the year resulted in a 356% increase in net income. That's leverage!

Source: Edward O. Welles, Going for the Green," Inc., July 1996, pp.68-75.

Relevant Articles:

Contribution Margin
Contribution Margin Ratio (CM Ratio)
Contribution Margin Income Statement
Break-even Point Analysis
Target Profit Analysis
Margin of Safety (MOS)
Operating Leverage
Break even Analysis with Multiple Products
CVP Consideration in Cost Structure
Importance of Cost Volume Profit (CVP) Analysis

 

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
----------------------------------------------------------------------------
  Special Journals
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  Cash Book
----------------------------------------------------------------------------
Bank Reconciliation Statement
----------------------------------------------------------------------------
  Final Accounts
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  Work Sheet
----------------------------------------------------------------------------
  Capital and Revenue Items
----------------------------------------------------------------------------
  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
----------------------------------------------------------------------------
  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
----------------------------------------------------------------------------
  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 

 

 

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