Question

Explain how a shift in the sales mix can affect the break-even point and net operating income. Please explain with some examples.

Answer 1

* SALES MIX is mixture of sales of all items that are sold by a particular business. * A business may be selling more than one item and contribution from each item may not be the same. * Also, fixed cost for each item may be different which will lead to different break even point for each item. * Break even point is that point at which there is no profit and no loss. Thus, any change in sales mix will change the break ven point due to change in total contribution and thus will change the operating income as well. EXAMPLE 1:- A car selling company plans to sell 50,000 units of car in a year. Out of this 25,000 are low profit models; 15,000 are high profit models and 10,000 are very high profit models. Thus, sales mix is 40%, 30% and 20% respectively. However, actual sales was only for 45,000 cars in that particular year. Out of this 20,000 are low profit models; 20,000 are high profit models and 5,000 are very high profit models. Thus, sales mix is 44.45%, 44.45% and 11.10% respectively. This is what is change in sales mix of the company. EXAMPLE 2:- A shopkeeper sells two types of pens. Selling Price Variable Cost Cont Pen 1 10 4 Pen 2 20 10 Fixed Cost 15,000 10 Selling Price for Pen 1 is Rs 10 and that of Pen 2 is Rs 20 Variable Cost for Pen 1 is Rs 4 and that of Pen 2 is Rs 10 Total Fixed cost for him Rs 15,000 He expects both pens to sell 50% and 50% At 50% each pen, break even point will be:- Fixed Cost for each pen = 15000 / 2 = Rs 7500 Pen 1 = Fixed Cost / Contribution = 7500 / 6 = 1250 pens Pen 2 = Fixed Cost / Contribution = 7500 / 10 = 750 pens At this level, operating income = 0 Now if he sells 50-50% pens then, Quantity of pen 1 sold = 2000 * 50% = 1000 Contribution from pen 1 = 6*1000 = Rs 6000 Quantity of pen 2 sold = 2000 * 50% = 1000 Contribution from pen 1 = 10*1000 = Rs 10,000 TOTAL CONTRIBUTION = 10,000+ 6000 = 16,000 Less Fixed Cost = Rs 15,000 Operating Income = Rs 1000 Thus change in sales mix changed the Break Even Point and operating income as well. EXAMPLE 3:- At 40-60% in above example Break Even Point Calculation, Fixed Cost for Pen 1 = 15,000 * 40% = Rs 6000 Fixed Cost for Pen 2 = 15,000 * 60% = Rs 9000 Break Even for Pen 1 = 6000 / 6 = 1000 pens Break Even for Pen 2 = 9000 / 10 = 900 pens Sales mix of 1000 Pen 1 and 900 Pen 2 is break even point. Again, actual sales are 75-25% Fixed Cost for Pen 1 = 15,000 * 75% = Rs 11,250 Fixed Cost for Pen 2 = 15,000 * 25% = Rs 3,750 Break Even for Pen 1 = 11250 / 6 = 1875 pens Break Even for Pen 2 = 3750 / 10 = 375 pens Sales mix of 1875 Pen 1 and 375 Pen 2 is break even point. If quantity sold is more then decided then operating income will be generated.