The structure and dynamics of costs and revenues vary from one company to the next. They vary based on the volume produced and sold. Managerial economics, corporate finance, and cost accounting overlap in measuring and analyzing these relationships.

The goal of managers is to maximize profit. Managerial economics is a set of tools to minimize costs and maximize revenues. It applies the techniques of microeconomics to total, average, and marginal costs. It determines levels of costs and revenues that optimize profit. Cost accounting and economics overlap in the field of managerial economics. We will now look at several very useful cost and revenue analysis techniques.

Break Even Analysis

The break-even point is a concept used in economics and business. It is derived from cost accounting data. It is the number where total costs, fixed and variable, and total revenue are equal. It is the number of units that need to be sold so there is no net loss or gain.

At break-even, all the costs are covered. The profit at the breakeven point is 0. This is the point after which additional sales will contribute to a profit.

The break-even point is the sales amount required to cover total costs. Total costs are both fixed and variable costs. It can be measured either in units or revenue. Break-even is only possible if the price charged per unit is higher the variable cost per unit. The difference between price and variable cost contributes toward covering fixed costs. We call this amount the Contribution Margin.

The goal of business is to make a profit. Break-even analysis determines the sales that must be exceeded to make a profit. It is a measure of the sustainability of a business. It also measures the impact of marketing campaigns.

The break-even point is clear and direct analytical tools for management. It provides insight into the relationship between revenue, costs, and net income.

The retail industry tracks break even on an annual basis. Break-even in retail doesn’t usually occur until late in November. That is why we call the Friday after Thanksgiving Black Friday. That is when most retail operations go from operating in the “red” (at a loss) to operating in the “black” (making a profit). Red and black refer to the ink colors used in accounting ledgers to denote a loss or a profit.

Target Income Sales

The break-even point relates to the concept of Target Income Sales.

Target Income Sales is the required revenue to achieve a budgeted profit goal. A CEO may focus on a target net income (profit) number. This goal needs translation into a sales revenue target for the sales team. Target Income Sales is a way of backing out the sales required to achieve a profit goal.

The calculation is similar to breakeven analysis. Here is the formula:

(Fixed costs + Target income) ÷ Contribution margin percentage

Lets say a company’s president wants to achieve profits of $1,000,000. The firm’s fixed costs are $2,400,000 and the average contribution margin percentage (revenue minus variable costs) is 40%. In this case Target Income Sales is $8,500,00:

($2,400,000 Fixed costs plus $1,000,000 Target income)/40% Contribution margin percentage = $8,500,000

The Target Income represents the desired income point. Target Income Sales are the sales targets developed in the budget.

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