Cost behavior and operating income

At the heart of break-even point or break-even analysis is the relationship between expenses and revenues. It is critical to know how expenses will change as sales increase or decrease. Some expenses will increase as sales increase, whereas some expenses will not change as sales increase or decrease.

Variable Expenses

Variable expenses increase when sales increase. They also decrease when sales decrease.
At Oil Change Co. the following items have been identified as variable expenses. Next to each item is the variable expense per car or per oil change:

Motor oil

$ 5.00

Oil filter

3.00

Grease, washer fluid

0.50

Supplies

0.20

Disposal service

0.30

Total variable expenses per car

$ 9.00

The other expenses at Oil Change Co. (rent, heat, etc.) will not increase when an additional car is serviced.

For the reasons shown in the above list, Oil Change Co.’s variable expenses will be $9 if it services one car, $18 if it services two cars, $90 if it services 10 cars, $900 if it services 100 cars, etc.

Fixed Expenses

Fixed expenses do not increase when sales increase. Fixed expenses do not decrease when sales decrease. In other words, fixed expenses such as rent will not change when sales increase or decrease.

At Oil Change Co. the following items have been identified as fixed expenses. The amount shown is the fixed expense per week:

Labor including payroll taxes and benefits

$1,200

Rent and utilities for the building it uses

700

Depreciation, office and professional, training, other

500

Total fixed expenses per week

$2,400

Mixed expenses

Some expenses are part variable and part fixed. These are often referred to as mixed or semi-variable expenses. An example would be a salesperson’s compensation that is composed of a salary portion (fixed expense) and a commission portion (variable expense). Mixed expenses could be split into two parts. The variable portion can be listed with other variable expenses and the fixed portion can be included with the other fixed expenses.

Revenues or Sales

Revenues (or sales) at Oil Change Co. are the amounts earned from servicing cars. Oil Change Co. charges one flat fee of $24 for performing the oil change service. For $24 the company changes the oil and filter, adds needed fluids, adds air to the tires, and inspects engine belts.
At the present time no other service is provided and the $24 fee is the same for all automobiles regardless of engine size.
As the result of its pricing, if Oil Change Co. services 10 cars its revenues (or sales) are $240. If it services 100 cars, its revenues will be $2,400.