4 Planning & Budgeting

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. Hair shampoo used on all clients is .40 per client. 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.

1. Find the contribution margin per haircut. Assume that the barbers' compensation is a fixed cost. Show calculations to support your answer.

• Contribution margin is the marginal income per unit sold. The formula is the per unit sales price minus the variable cost per unit. For Andre, with a sales price of $12.00 and a variable cost of $0.40 per cut, his Contribution Margin (income per cut) is $11.60:

unit sales price $ 12.00

- variable cost $ 0.40 shampoo

= cont margin $ 11.60 = $12 - $0.40

2. Determine the annual break-even point, in number of haircuts. Support your answer with an appropriate explanation. Show calculations to support your answer.

• Break-even point is the level at which the amount of sales revenue equals the expenses, therefore, canceling out any net income. The formula is to divide the Total Fixed costs by the Contribution Margin. In this example, to find the annual breakeven point, extra calculations were made to bring all variables into the correct units. Andre needs to sell 10,345 hair cuts a year in order to break even (please see calculations below):

fixed cost $120,000.00 = ($9.90/hr * 5 BARBERS * 40hrs/wk * 50wks/yr)

+ ($1750 monthly rent * 12 months)

/cont margin $ 11.60 from q1

break even 10,344.83 = $120k / $11.60

3. What will be the operating income if 20,000 haircuts are performed? Show calculations to support your answer.

• To find the net income for 20k cuts in one year, we have to find the total contribution margin, and the new variable cost (as variable costs change with the number of units sold). At $12 a piece, our new Sales price is $240k, and our new variable cost is $8k. As we saw in question 1, we now know that the contribution margin is ($240k - $8k =) $232k. If we subtract from that the fixed cost (which haven’t changed since question 3, $120k), we get a total net income of $112k (please see calculations below):

units 20,000.00

sales $240,000.00 = 20k cuts * $12 each

variable