Cost, Profit, and Break-Even (1980) - full transcript

250, 300, 350.

350, are you done?

400, 400, 400.

[GAVEL BANGING]

Fly press with dies and punches.

Finally, lot 74,

Managing Director.

Good condition, brain hardly

used, who's going to start us off?

Do I hear 100 pounds?

- No.

10 pounds?

1 pound?

10 pence?

- Yeah, OK.

10p.

Well, it's a perfectly

reasonable umbrella.

Scrubs, 10p.

I do not understand.

I simply do not understand.

No? Well, I suppose I

just felt sorry for you

after everything my

brother told me about you.

That is not what I

do not understand.

Ah.

How can it happen that a man, an

intelligent, enterprising man,

can be declared bankrupt

when he has money in the bank

and he's selling his

goods at a profit?

Quite easily.

Tell me about it.

After all, we are both

in the same business.

But I am upmarket, and

you are downmarket.

I know. But then my business

is booming, and yours is bust.

Isn't it absurd?

Is there no justice in business?

No.

But there is logic.

So tell me about it.

Very well.

I had a brilliant idea, one of the

greatest creative ideas of the century.

Look, Carruthers

Coupled Cutlery,

ideal for buffet lunches, family

picnics, and camping holidays.

The knork slices the

sausage with one end,

spears it with the other.

The spork fixes the

strawberry on one end,

scoops up the cream

with the other.

The spife takes the jam with one

end, spreads it with the other.

The hiker's friend like Campus

Companion, Carruthers Coupled

Cutlery.

And what's more, the

inventive brilliance

was matched by the

financial sophistication.

- It wasn't.

- It was.

I can't wait to hear about it.

Let me demonstrate.

I calculated that I could sell my

coupled cutlery for 200 pounds a case,

and that I could produce

and sell 10 cases a week.

Total sales revenue,

2,000 pounds a week.

But I went into

even more detail.

I worked out that my costs would

be only 1,000 pounds a week,

labor, material, and overhead.

That meant a thousand pounds a

week profit on 10 cases. See?

Or to make things easier for

simpler minds, 100 pounds

cost per case leaving 100

pounds profit per case.

Highly satisfactory.

So what went wrong?

Nothing.

Well, nothing, really.

It was just that I only managed

five crates a week instead of 10.

Ah.

That's with 100 pounds

profit per case.

That simply meant

500 pounds profit

a week instead of 1,000 pounds.

Man can jog along on 500 a week.

So why aren't you jogging along?

That is what I do

not understand.

Could you show me how you arrived at

that 1,000 pound figure in detail?

You mean in even greater detail?

Very well.

Income, 10 cases at 200

pounds each, 2,000 pounds.

Expenditure, strip

metal, 10 consignments,

35 pounds each, 350 pounds.

Lubricants, packaging,

and so on, 50 pounds.

Part-time labor,

bit of extra typing,

bit of help on

sales, 100 pounds.

The three lads at 100 pounds

a week each, 300 pounds.

Overheads and general

marketing, 200 pounds.

Total expenditure, 1,000 pounds.

Subtract from income of 2,000

pounds, profit, 1,000 pounds.

There.

How was that?

Very good, except

it didn't happen.

But it, it, it half happened.

Oh, yes. Would you mind changing

it to show what actually happened?

Why? I mean, it's

bound to come out

at 500 pounds profit instead

of a thousand pounds.

Even so.

[SIGH]

Have to spell it

out for some people.

Right, income down

to 1,000 pounds.

Now, half the strip

metal is 175 pounds.

Half the lubricant is 25 pounds.

Half the part-time

labor is 50 pounds.

Labor, well, that's three

lads at 100 pounds a week.

And why still three lads

with only half of 10 labor?

Well, you can't just take on and

lay off skilled lads like mine.

They'd be off to someone

else like a flash.

I have to guarantee

them their jobs.

You mean they're staff?

Well, I don't eat with

them, obviously, but yeah.

Yeah, staff, yes.

Three at 100 pounds is 300 pounds,

and overhead still 200 pounds.

Which makes total expenditure?

[MUMBLING]

It is 750 pounds.

Ooh, very nice.

So 1,000 pounds take away

750 pounds is 500 pounds

Precisely.

What?

1,000 pounds take

away 750 pounds?

But I don't understand.

I'm doing half the business, but I've

only made here a quarter of the profit.

It must be some mistake.

Yes, there has been a mistake,

all right, but not there.

Look.

You worked out that 10

cases, 2,000 pounds of sales,

cost 1,000 pounds to produce and

sell, and left 1,000 pound profit.

Quite true.

But let's look at those costs.

200 pounds overhead

and marketing,

300 pounds for the

lads, that's 500 pounds.

And 500 pounds for

the rest, 100 pounds

for part time labor, 50

pounds for lubricants

and so on, and 350

pounds for metal.

But cut your turnover

by half to 1,000 pounds,

and see what happens.

Overheads don't change,

still 200 pounds.

Staff costs don't

change, still 300 pounds.

The other costs, metal, lubricants,

casual labor, they do change.

They come down from 500

pounds to 250 pound.

But it only leaves

you 250 pounds profit.

So that makes your cost per case

look just a little bit different.

If you're producing only five

cases a week instead of 10,

costs now take up 3/4 of the

price of each case, 150 pounds,

and profits are only

a quarter, 50 pounds.

But-- but-- but those are

just accountants' figures.

Ooh, certainly.

And bank managers' figures,

and receivers' figures,

and judges' figures.

Well, what is a decent,

honest chap supposed to do?

A decent, honest chap can start

by separating his fixed costs

from his variable costs.

Remember we compared

your forecast turnover

of 2,000 pounds with your

actual turnover of 1,000 pounds?

Well, take a look at that costs.

Some of them didn't change.

Staff and overhead were the

same whatever the turnover.

They are fixed costs.

The other costs only arose when

you produced cutlery metal,

and lubricants, and so on.

They are variable costs.

500 pounds on 10 cases,

250 pounds on five,

50 pounds a case.

So your variable costs

are 50 pounds a case.

Fascinating.

He is telling me that I make

150 pounds profit on each case.

That is not what

I'm telling you.

That is not what

he is telling me.

[CLEARS THROAT]

What are you telling me?

I am telling you that

we are now in a position

to look for the missing figure.

What missing figure?

The key figure for any

new project, the one

figure you have to

know before you start.

- Which is?

- Which is-- what?

The break-even figure.

Look, you worked out that 10

cases gave you 1,000 profit.

Now what's the maximum

you can produce a week?

16, top whack.

But how many do you have to

sell just to stay in business?

Nine.

One? Five?

- I don't know.

- Oh.

Not yet. But now we're in

a position to work it out.

Now we know that each case has

a variable cost of 50 pounds.

And 150 pound profit.

- Not 150 pounds.

- Not?

How can it be profit if

you haven't paid the rent,

or paid the lads, or

paid your heating bills?

The fixed costs.

- Ah.

The 150 pounds that's left

after paying the variable costs

is a contribution towards

those fixed costs.

Once you've paid

those, then it's

a contribution towards profit.

At the moment, all

we know is that it's

150 pounds contribution.

It's the value you and your

lads have added to the metal

and so on that you bought

by turning it into cutlery.

Your fixed costs were

500 pounds, remember?

Well, you can think of them

as a hole 500 pounds deep.

Each case makes 150

pounds contribution

to filling that hole.

So two cases pay off 300

pounds of the fixed cost,

three pay off 450 pounds,

and with the fourth case,

you pay off the last 50 pounds

and make 100 pound profit.

If you make a fifth case

that week, then in that case,

as a 150 contribution, is

indeed profit, all of it.

In fact, your break-even in that example

is three and a third cases a week.

You see?

I knew it.

Typical.

Absolutely typical.

- I beg your pardon?

- Three and one third cases a week.

I was producing five.

I was making a profit.

I'm a success. Excuse me,

I must go and tell them.

- Wait a minute.

- What, what, what?

I said in that example.

There was something I

left out of that example.

Why?

Because there are some minds

that cannot take any more than

one idea at a time, if that.

What have we left out?

Depreciation of fixed assets.

Ah, of course.

You understand depreciation?

Obviously.

How would you describe it?

Uh, well, I'm not awfully

good at the describing lark.

But I'd be also interested

to know how you made out.

Thank you.

Tell me, how much

did you pay for all

of your machines, cutters,

dies, presses, and so on.

Uh, 20,000 pounds, the whole

of Aunt Agatha's legacy.

And how long until you

have to replace them?

- Ages. Ages.

- How long?

Oh, a good five years.

- And then you go out of business?

- No, then I buy some more.

- What with?

- Profits?

I suppose they're not enough.

I suppose you've spent

them on something else.

Oh, all right.

Tell me.

Right, depreciation.

You started with Aunt Agatha's

legacy, 20,000 pounds,

and you turned it

into machine tools.

But it was still

worth 20,000 pounds.

You just put it into

machines instead of the bank.

But as you use a

machine, you start

to use it up just as if you

were spending the money.

Each case of cutlery

takes a tiny bit

of the machine's value with

it, as well as the strip metal.

It's another cost of production.

And after five years,

the machine's whole value

will be gone.

You will have spent

the whole machine.

So part of your sales

income has to be

set against the invisible

expenditure of machine value.

And that's depreciation.

[COINS CLANKING]

It may look like money in the

bank, but in five years' time,

you're going to need all of

it to replace your machines

and stay in business.

Using up 20,000

pounds over five years

means using up

4,000 pounds a year.

And you'll have to

allow another thousand

a year for rising prices because

those machines won't still

cost 20,000 pounds

in five years' time.

That means setting aside a total

of 100 a week for depreciation.

So that hole isn't

500 pounds deep.

It's 600 pounds

deep, which means

that 100 pounds

bit of contribution

from the fourth case

isn't profit after all.

It's swallowed by depreciation.

So your break-even is four

cases, not three and a third.

Their contribution has to

pay for 200 pounds overhead,

300 pounds labor, and

100 pounds depreciation.

600 pounds of fixed

costs, four contributions

of 150 pounds each.

So my break-even is four cases.

- So it seems.

Well then, what is all this

bankruptcy charade it [INAUDIBLE].

I was turning out five cases.

I'm laughing, aren't I?

Apparently not.

Uh, could there be

anything you've forgotten?

- No.

- Good.

Tell me how you started

this fascinating business.

Ah, what a story.

All my own idea.

Got a die maker, a prototype,

market tests redesigned,

wonderful publicity campaign.

Look at that.

Ads, mailshots, launched at a

buffet lunch served exclusively

with Carruthers Coupled Cutlery.

Triumph, triumph.

- When was all this?

Oh, uh, just over 12 months ago.

And how much did all these cost?

Well, you don't spoil a

ship for a ha'porth of tar.

Oh, no, no.

25,000 pounds.

And where did that come from?

No, it's perfectly alright.

I got a loan.

- Interest rate?

- 20%.

- Security?

- Machines, patents, trademarks.

- Repayable when?

- Just over 12 months.

And how much have been repaid?

Well, it's been a bit--

- Nothing?

- Sort of nothing.

- I see.

- What do you see?

I see why you aren't laughing.

Look, we said your

fixed costs were

200 pounds overhead, 300

pounds labor, and 100 pounds

depreciation, right?

Right.

But 20% interest on 25,000

pounds is 5,000 pounds a year.

That's a further

100 pounds a week.

Then there's the loan

itself, 25,000 pounds

to repay after a year.

That means setting

aside 500 pounds a week

for loan repayment, which

means your fixed costs aren't

600 pounds.

They're 1,200 pounds.

And how many 150 pounds

contributions is that?

Uh, 1, 2, 3, 4, 5, 6, 7, and 8.

8 contributions.

So break-even is

eight cases a week.

And you are producing?

Five.

So you needed three

more just to break even,

four more if you wanted

to make any profit.

So what are you telling

me I should have done?

Produced a business plan

based on a break-even figure

worked out in advance.

You mean just as

you would have done?

Yes.

It's called marginal costing.

Actually, there is another way.

Total absorption costing.

Oh, please don't-- don't

confuse me with information.

It's simple, really.

Look, how much would it cost

you to produce one case a week?

Ah, I can do that.

1,200 pounds fixed

cost, 50 pounds

variable cost, 1,250 pounds.

And if you produce two cases?

What would they cost each?

Simple, half of that, which is--

What about the variable

costs on the second case?

Ah, as I was saying, half 1,300

pounds, which is 650 pounds.

- Three cases?

- Well, a third of 1,300 uh, 1,350.

And 3 into 13-- go 3 into--

- Four cases?

- It's four of-- what?

- Five cases?

- Well, hang on.

- Hang on, old chap.

- Just a second. Don't worry.

Notice, I've done it

all for you, look.

Five cases cost 290

pounds each to produce.

Six comes downs to 250.

Eight comes down

to 200 pounds each,

which is your break-even

figure, remember?

If you get up to

16, they're only

costing you 125 pounds each.

75 pounds contribution per case?

No, 75 pound profit.

That 125 pounds has absorbed

all your fixed costs already.

So it has.

75 pounds profit, good lord.

So if you want to use total

absorption costing instead

of marginal costing, you

can plot it like this.

No, it's a graph.

I don't believe in graphs.

Why not?

Well, I don't understand them.

Well, it's perfectly simple.

It says the same thing

in a different way.

Look, that is the

number of cases

you sell a week, taking 16

as the practical capacity,

and 4 to 16 as the

relevant range.

- Beg your pardon?

- Never mind, never mind.

That is the cost of

producing each case.

Production volume, production costs.

- Very clever.

But what does all that get you?

Well, suppose you reckon you

can sell 10 cases a week.

You just read up

the 10 line, and you

will see that each case will

cost you 170 pounds to produce.

So you've got to charge more than

170 pounds a case to make a profit.

If you charge less,

you're in the red.

Or you can do it the other way.

If you reckon that

200 pounds a case

is the most you can charge, just

read along the 200 pounds line,

and you will see you've got to produce

at least eight cases to break even.

Produce less, and

you're in the red.

But-- but if I had done

that and found it was eight,

this whole magnificent enterprise

would never have started.

I knew I couldn't guarantee

selling eight a week.

Yes, a business plan

does stop people

from starting up

doomed projects,

but it also gives you a chance

to look at alternatives.

- Could you have cut your variable costs?

- Nope.

- Used less labor?

- Nope.

- Charged more per case?

- Not a hope.

- Charged less per case?

- Oh, brilliant.

The man is a commercial genius,

business brain of the century.

You're going bankrupt,

you must cut your profits?

How many cases would you

sell at 150 pounds each?

- Oh, I'd sell a lot.

- How many?

15 a week at least.

- So?

- Hm?

What would 15 cost you each?

Well, how should I know?

But-- yes, but I've never

driven one of these.

That doesn't matter.

Nobody is looking.

But this thing can't

be working properly.

Why?

Well, it says 130 pounds.

I know.

But that's 20 pounds cont--

20 pounds profit per case.

Right.

- 15 cases?

- Right.

- 300 pounds profit a week?

- Right.

[LAUGHTER]

- I'm rich.

- No, you're not. You're bankrupt.

I am a retrospective

millionaire.

The bankruptcy courts are full

of retrospective millionaires.

But-- but my idea works.

If you are right about selling

15 cases 150 pounds each,

and if you can actually

produce 15 cases a week,

and if you can still keep your

fixed costs at 1,200 pounds,

and if you can--

- Forget the trivialities.

I was on to a good

thing all along.

You may have been on to a good

thing at 150 pounds a case.

Seems you're on to a bad

thing at 200 pounds a case.

But now that I

know all about it--

Do you know all about it?

Tell me.

All right, I will.

First, marginal costing.

You divide your production

costs into two different kinds.

Fixed costs, the ones you

have to pay whatever happens,

and variable costs,

the ones you only

pay when you produce something.

The difference between

the variable cost

of the product and

the price you charge

for it is the contribution,

contribution to fixed cost

until they're all paid up.

When they are, that's

your break-even figure.

After that they are

contribution to profit.

Second, total-- total-- total--

Total absorption cost--

I know, I know.

I was just getting around to it.

Total absorption costing.

That way, you take the total

costs, fixed and variable,

and divide them by all the

different numbers you might sell.

That enables you to work out

a different unit cost figure

for all the different volumes.

You can even plot

them on a graph,

if you go into

that sort of thing.

With the graph, you

can take a given volume

and see what each unit

would cost to produce,

or you can take a given

price and see how many units

you need to produce to

keep your costs down to it.

Very good.

Very good, indeed.

12 months too late, but

very good all the same.

And now, if you'll excuse me.

- Well, where are you going?

Oh, I've got a little

business to sort out.

Cutlery business. Lent them

25,000 pounds a year ago,

good security, machines,

patents, trademarks.

Now they've gone bust.

- Really? Why?

Never worked their costs out,

never had a business plan

how to price their products.

That was that.

[LAUGHTER]

Cheers.

- Cheers.

[LAUGHTER]

Never worked their costs out.

Ha, ha!

[MACHINES RUNNING]