Part VII: Breakeven

(excerpted from The Pipeline: A Picture of Homebuilding Production, originally posted on Escape from Averageness in July 2010, updated and reposted here)

“Someone might as well ask the question”, said the intrepid, results-based consultant.  “From both a production standpoint and a financial standpoint, at what point does RB Builders breakeven?”

“One of the advantages and benefits of allocating costs on the basis of how they behave in relation to Revenue is the ability to understand and use breakeven analysis”, replied the CFO.  “I have to admit, before you came, we could not have answered that question.  The RB Builders Income Statement was prepared according to the NAHB Chart of Accounts, which is to say that it was comparative, compliant . . . and utterly useless.  Now, we also produce an internal Contribution Income Statement.

“According to the 2008 baseline budget, our breakeven point is 155 closings, based on Revenue of about $39 million.  However, because of the way the market has deteriorated, the 2008 target budget has a higher production breakeven point;  it requires closer to 170 closings, albeit on only slightly higher Revenue of $40.5 million.”

“How did you calculate that?”, asked the VP of Construction.

“Let me show you”, said the CFO, creating a new data table.  “This is what we have said, so far;  some parts we do not know yet.”

 

2008 BASE BUDGET

  • CLOSINGS = 200
  • REVENUE = $50,000,000
  • AVG. SP = $250,000
  • GROSS MARGIN = 22%
  • BREAKEVEN = 155 UNITS
  • BREAKEVEN REVENUE = $39,000,000

 

2008 TARGET BUDGET

  • CLOSINGS = 250
  • REVENUE = $60,000,000
  • AVG. SP = $240,000
  • GROSS MARGIN = 21%
  • BREAKEVEN = 170 UNITS
  • BREAKEVEN REVENUE = $40,500,000

 

2008 WORST-CASE

  • CLOSINGS = 140-150
  • REVENUE = $34,500,000
  • AVG. SP = $240,000
  • GROSS MARGIN = 18-19%
  • BREAKEVEN = ?
  • BREAKEVEN REVENUE = ?

 

2008 FULL CAPACITY UTILIZATION

  • CLOSINGS = 300
  • REVENUE = $69,000,000
  • AVG. SP = $230,000
  • GROSS MARGIN = 15%
  • BREAKEVEN = ?
  • BREAKEVEN REVENUE = ?

 

“Breakeven occurs at the point where overhead is completely absorbed”, he said, continuing to write as he spoke.  “Overhead is absorbed through the generation of Gross Income, which is the proceeds that we get to keep from each closing.  When you are dealing with averages, one way to figure the breakeven point is to take the average sales price of a home, multiply it by the Gross Margin Ratio, and then divide the resulting Gross Income per home into your overhead.”

BREAKEVEN = OVERHEAD ÷ (AVG SP X GM%)

BREAKEVEN = $8,500,000 ÷ ($250,000 X 22%) = 155

“That gives you the unit breakeven point, in other words, the breakeven point in terms of closings.  The unit breakeven point in the 2008 Baseline is 155 closings.”

“Do you have another way to look at breakeven?”, asked the intrepid, results-based consultant.

“Sure”, he said, writing on the board.  “You can calculate the breakeven point in terms of Revenue, by dividing overhead by the Gross Margin Ratio, which is basically the same as Contribution Margin.

“Take the 2008 Baseline and Target we were just discussing.”

BREAKEVEN = OVERHEAD ÷ GM%

BASELINE BREAKEVEN = $8,500,000 ÷ 22% = $38,636,000

TARGET BREAKEVEN = $8,500,000 ÷ 21% = $40,476,000

“About $39 million and $40.5 million, respectively”, he said, pointing back to the data table.  “Our overhead under both the 2008 Baseline or the 2008 Target is $8,500,000, but the resulting Gross Margins are different, so the breakeven points are different.  In this case, the difference in the unit breakeven point is more substantial than the difference in the Revenue breakeven point.

“Overhead is the same thing as Operating Expense, which is comprised of all our indirect, non-variable costs.  Overhead – or Operating Expense – is the cost of our production capacity.

“That gives you the breakeven number of closings, and the breakeven Revenue;  equally-important – since we cannot generate all of our closings and all of our revenue at once – is the breakeven rate.”

 

(The Pipeline: A Picture of Homebuilding Production is available on the publisher website (virtualbookworm.com), and the author website (thepipelinebook.com), as well as amazon.com, barnesandnoble.com, and booksamillion.com)