There are two types of barber costs: fixed and variable. The variable costs are those that change according to the number of haircuts, i.e. the shampoo per client. The rent and salary for the five barbers are fixed costs that remain constant regardless of output level. As a result, the variable cost is $0.4, and the annual fixed costs are $120,000. (99,000 wages and 21,000 rent and fixed expenses). With a unit price of $12, the contribution margin per haircut (sales minus variable costs) is $11.6. The break-even point will refer to the point at which the revenues cover both the fixed and total costs, that is, revenues equal to total costs. It is given by the total fixed costs divided by contribution margin and, therefore, the break-even number of annual haircuts is 10,345 (120,000/11.6). The meaning is that at 10,345 haircuts, the revenue is equal to the cost. Therefore, to earn a profit, the number of haircuts must be greater than 10,345, and if they fall below the point, a loss will be made. If the barber gives 20,000 haircuts in a year, the operating profit will be $112,000. The contribution margin is 232,000(11.6*20,000) while the fixed expenses are $120,000. (Operating income=232000-112000=120,000).
If you change the compensation to $4 per hour and $6 per haircut, the variable and fixed costs will change. The new variable costs will be $6.4 (barber wage of $6 plus $4 shampoo per client) while the fixed costs will be $61,000 (rent of 21,000 plus an hourly wage of 61,000). The new contribution margin will be $5.6 (12-6.4) and the break-even analysis 10,893 haircuts (61000/5.6). Changing the compensation system increases the break- even number of haircuts from 10,345 to 10,893. It means that the business will have to give more 548 haircuts to earn a profit and, therefore, the new compensation method should not be implemented. The existing compensation plan of $9.9 per hour is more suitable, and you should continue it.
