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 Subject: Business Accounting Category: Business and Money > Accounting Asked by: tra5489-ga List Price: \$30.00 Posted: 21 Mar 2005 18:21 PST Expires: 20 Apr 2005 19:21 PDT Question ID: 498331
 ```Andre has asked you to evaluate his business, Andre?s Hair Stylling. Andre has five barbers working for him. (Andre is not one of them.) Each barber is paid \$9.90 per hour and works a 40-hour week and a 50-week year, regardless of the number of haircuts. Rent and other fixed expenses are \$1,750 per month. Assume that the only service performed is the giving of haircuts, the unit price of which is \$12. Andre has asked you to find the following information. Find the contribution margin per haircut. Assume that the barbers? compensation is a fixed cost. Show calculations to support your answer. Determine the annual break-even point, in number of haircuts. Support your answer with an appropriate explanation. What will be the operating income if 20,000 haircuts are performed? Show calculations to support your answer. Suppose Andre revises the compensation method. The barbers will receive \$4 per hour plus \$6 for each haircut. What is the new contribution margin per haircut? What is the annual break-even point (in number of haircuts? Show calculations to support your answer.```
 ```Tra5489 ? To figure Andre?s Hair Styling contribution margin, you start first with fixed costs: LABOR: \$9.90 * 40 * 50 * 5 barbers = \$99,000 OVERHEAD: \$1,750 * 12 = \$21,000 TOTAL COSTS = \$120,000 --- Now on to breakeven point: BREAK-EVEN = HAIRCUTS * \$12 = TOTAL COSTS 10,000 haircuts * \$12 = \$120,000 So, the breakeven is 10,000 haircuts. Note that on a 6-day workweek (312 days), that would be 32 haircuts per day or about 6.4 per barber. On a 5-day workweek (260 days), that would be 38.5 haircuts per day or about 7.7 per barber. Also note that at breakeven there is no contribution margin ? costs are only being covered. It?s also important to note that this is NOT a standard industry definition. Normally labor costs would be considered to be variable costs and you?d add hours of work as the business demands it. See this definition of ?contribution margin? from About.com?s excellent pages on the Retail Industry: About.com ?Contribution Margin? http://retailindustry.about.com/cs/first_timers/l/bldcontmargin.htm However, since THIS PART of your question deals with the barber?s salaries as fixed costs, both salaries and rent/expenses (overhead) have to be lumped together. At least for now, our Variable Costs = 0. --- OPERATING INCOME ================== With a volume of 20,000 haircuts, it would produce: ANNUAL REVENUES = \$12 * 20,000 = \$240,000 OPERATING INCOME = REVENUES ? (FIXED COSTS + VARIABLE COSTS) = \$240,000 - \$120,000 = \$120,000 --- CONTRIBUTION = OPERATING INCOME = \$120,000 CONTRIBUTION PER HAIRCUT = \$120,000 / 20,000 haircuts = \$6.00 per haircut CONTRIBUTION MARGIN = % of income per haircut = \$6 / \$12 = 50% --- NEW MODEL =========== What?s important in this problem is to show how contribution margin works. As noted in that About.com definition above, it?s what is available to cover fixed costs. In the New Model, the PER HAIRCUT costs now are no longer in fixed costs. The fixed costs are simply \$61,000 ? which consists of: BARBER?S BASE PAY: \$4 * 40 * 50 * 5 barbers = \$40,000 OVERHEAD: \$1,750 * 12 = \$21,000 TOTAL FIXED = \$61,000 It?s nice to have a lower total fixed cost, as this is about half of the previous cost. But we?ve added a Variable Cost of \$6 per haircut to Andre?s business. It makes it a little harder to figure out the breakeven. Why? Because at 10,000 haircuts the Fixed Costs are \$6.10 per haircut and his Variable Costs are \$6 per haircut ? and he?s losing money: NEW CONTRIBUTION = REVENUES ? (FIXED COST + VARIABLE COST) At 20,000 haircuts, he makes money, though he?s making less: \$240,000 ? (\$61,000 + \$120,000) = \$59,000 or \$2.95 per haircut, which is 24.6% and profit per haircut is less than half what it was previously. --- NEW BREAKEVEN ================ What?s the point to this problem? It?s that some costs are Fixed and some are Variable in most businesses. And that contribution or contribution margin will depend heavily on revenues or volume. Breakeven for Andre?s Hair Styling will come when his Fixed Costs/Haircut are \$6 ? because he already has a Variable Cost of \$6/haircut that he?s paying to his employees. So it?s \$61,000 / haircuts = \$6, or 10,167 haircuts. Actually he?ll make a few dollars (not even \$10) because of some rounding errors in the math: REVENUES = 10,167 * \$12 = \$122,004 FIXED COSTS (FC) = \$61,000 VARIABLE COSTS (VC) = 10,167 * \$6 = \$61,002 INCOME = REVENUES ? (FC + VC) = \$2 So, Andre?s breakeven went up under the new pay scheme. Now if he?d only given the barbers \$5/haircut, it would have gone down . . . Google search strategy: ?contribution margin? definition Best regards, Omnivorous-GA```