In response to your request for an analysis of your business; Andre’s Hair Styling, I am pleased to inform you that I have done an extensive evaluation of the costs and the incomes from your business. From the evaluation, I have come up with some useful suggestions on how you could apply the analysis to monitor your business operations. A comprehensive relationship of the costs is also included.
The contribution margin per haircut is gross income from the haircut less the variable cost involved in the haircut service. The variable cost in this case is the hair shampoo used on each client while the gross income is the cost of the haircut. Therefore, the contribution margin is $11.60; subtract the cost of shampoo ($0.40) from the gross income from the haircut ($12).
The annual break-even point, in the number of the haircuts, is the number of the haircuts per year where annual gross income=annual operating expenses. Your annual operating expenses are given by annual barbers’ compensation+ annual rent. Each of the 5 barbers’ compensation being $9.90, the total annual compensation is $99000(5*9.90*40*50). The annual rent and fixed costs is $1250* 12 months which is equal to $21000. Therefore, the annual operating expenses are $120000($99000+$21000). Since the annual gross income is given by the number of haircuts* contribution margin of each haircut, the breakeven number of haircuts is attained by dividing the annual gross income with the contribution margin to get 10345 haircuts ($120000/$11.60).
Your operating income if 20000 haircuts are performed will be attained by subtracting your annual operating expenses from your gross revenue from the 20000 haircuts. Your gross revenue from 20000 haircuts will be $232000 (20000*$11.60). Since the annual operating expenses are $120000, the operating income from 20000 haircuts is $112000 ($232000-$120000).
On revision of the compensation scheme, the variable costs increase while the fixed costs reduce. The variable costs increase to $6.40 since for every haircut, besides the shampoo cost ($0.40), the barber is also compensated $6. Therefore the new contribution margin is $5.60 ($12-$6.40). Fixed costs reduce due to the reduction in compensation from $9.90 to $4. Consequently, the breakeven number of haircuts changes to 10893 haircuts (annual operating expenses: $61000/ new contribution margin: $5.60).
From the above, variable costs are the costs incurred in the service, such as shampoo and the new barber compensation per haircut. They affect the contribution margin from each haircut. Fixed costs, on the other hand, are those costs that are essential for the running of the business such as rent and other fixed expenses and the fixed barber compensation. They affect the operating expenses. Therefore, the total variable cost is dependent on the number of haircuts given while fixed costs are an independent quantity; they do not change whether haircuts are given or not.
Since variable costs are a dependent quantity on haircuts given, they are a clear and concise way of monitoring the productivity of the barbers; the more the variable costs, the higher the productivity and vice-versa.
All the best in your business.
Best, (Your name)
