A review report by the Irish National Transport Authority published in 2016 makes for some interesting reading. It highlights the issues faced by many rail companies world-wide in that not all routes are profitable. When this occurs, many States subsidise services in the general public and social interest.
The 2016 report includes an interesting use of a breakeven approach to identify poorer performing routes. The analysis calculated the cash per journey required to breakeven. This was done by taking total cash costs less revenue divided by the passenger journeys on each route. The report notes that all government subvention, capitalisation, depreciation and exceptional costs were excluded. It identified four poorly performing routes, as shown below.
What this graphic shows taking the first route as an example is that about €550 per passenger journey is needed to cover what we might classify as the running and maintenance costs.I like its simplicity, and I don’t think anyone would be prepared such a fare. Using such figures, the rail company or the State has to decide if it can subvent to that amount on an on-going basis. The latter to routes seem to be more workable in terms of a combination of increased fares, cost cuts and/or subvention.
I read a nice article in the Financial Times recently on the cost of buying a vineyard. The article is investment focused, but mentions that given costs of production, wine prices and annual sales in bottles, the investment will breakeven in a few years – meaning the investment is recouped. If you have studied management accounting, you’ll be aware this not breakeven in the way you many have learned it – fixed cost/contribution per unit. It is not very different though. In essence, the investment is regarded as a fixed cost, with the contribution per unit being the annual contribution which can be made from sales of wine in a year. It’s not a perfect measure, but a good enough rule of thumb to help make an investment decision.
Farmer’s, even if they know their costs, face a problem in that they can’t do anything about crop prices. If the price is above break even, it may even make sense to rent more land to grow more.
And of course, if a farmer knows the break even ‘cost’ per acre/hectare then they can try to get the best price above that.
Here is a good article showing the costs of corn this year, and working out a break even price. It’s a good example of the application of break even analysis.
In October of this year, Michelin star chef Derry Clarke had a go at Dublin restaurants selling “cheap meals” – see here. I guess Clarke was thinking from his own view when he said “the number of restaurants offering meal deals at economically non-viable prices just isn’t sustainable, it’s the same cost in McDonalds, but we have all of the overheads”.
He may have a point about the number of restaurants being sustainable, but Derry, stick to the cooking. Any management accountant could figure out that even if meals are sold cheap (and I doubt they are below cost as Clarke suggests), they still make a contribution towards overhead costs. It would be better to have 50 guests in a restaurant earning a contribution of €5 a head (€250 in total) than having an empty restaurant. In the latter case, costs such as labour, heating, rent and so on are still incurred.
In February this year, the United States Postal Service (USPS) decided to cease delivering mail on Saturdays. While this may be seen as inconvenient for some personal and business users, in management accounting terms it is probably a simple cost-volume issue.
Mail volumes have fallen globally due to email and other communications media. With falling volumes, a postal service would either have to reduce costs or increase revenues to maintain profits – or keep state subsidies low. Increasing revenues may be difficult given the competition is sectors such as parcel deliveries, which have increased in volumes. It is also difficult to raise postage rates given the political and/or state involvement. So this leave costs, or more specifically cost-cuts, to get things back in balance. Apparently, ceasing Saturday deliveries will save $2 billion annually. You can read more here from The Economist
Anyone who has started a business from scratch knows how hard it is in the early months (or even years). Lots of businesses seem to fail too in these early times. Why? Well, there are many reasons from just bad timing, to poor marketing, poor quality and so on. There is also the possibility that the business simply did not understand its costs structure and how this relates to the volume of sales needed to make a profit.
The US Small Business Administration (and similar organisations world-wide) provide good advice for start-ups. One key concept on understanding costs and volumes is called breakeven. This simply means the output level at which your business neither makes a profit nor loss. To keep it simple, if a business knows its start-up costs and running costs for the first year, it can easily work out the level of sales required to breakeven – this output level is known as the breakeven point. To work out the breakeven point, you need to separate variable costs and fixed costs. Fixed costs remain the same regardless of how much your business sells (e.g. rent) and variable costs change as the output grows (e.g. labour costs , shipping cost, material costs). For breakeven, the sales value less the value of variable cost must be equal to fixed costs; any surplus is a profit, any deficit a loss. Doing this quick sum could save many businesses from going under. In fact, as a management accountant I would suggest a breakeven calculation is included in all business plans. I would say that, but why go into business to lose money? Or at least know when you will start to make money?