Break even sales is the amount or volumes of sales that a company must realise in order to match the sum of its variable and fixed costs. (In other words, simply put, this is amount of sales a business must make in order to meet its costs.) If a business’s sales cannot at least match its costs then that business in not viable.

In other instances, a manufacturing business may also be able to determine the break even volume of production or the production capacity that it must operate at in order to break even. Please do not be put off by the formula below as it followed by a very simplified example.

The break even formula is as follows

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Fixed Costs =Breakeven Sales

*Contribution Margin

*Contribution Margin = 1- Variable Costs

Sales

As an example, for 2008 Eld Limited realised sales of $ 5 000 000 and had of fixed costs of

$1 000 000 and variable costs of $ 2 500 000. Eld Limited’s break even sales figure is worked out as follows

Eld Ltd’s contribution margin

1 - $ 2 500 000 = 1 - 0.5 = 0.5

$5 000 000

Eld Ltd’s breakeven sales

$ 1 000 000 = $ 2 000 000

0.5

A banker will be comfortable in dealing with a company like Eld Limited. The company has a sales figure of $5 000 000 but it requires sales of only $2 000 000 to meet its costs. The sales would therefore need to drop by at least $3 000 000 before we can begin ringing alarm bells. There is quite a huge gap of comfort.

However, the situation could have been very different if Eld Limited realised sales of $2 100 000 against a break even sales point of $ 2 000 000. If the sales were to drop by just more than $ 100 000, Eld Limited would be in trouble.

By the same token if a Eld Limited runs a bakery,. it will be possible for management to determine the breakeven sales volume. For example if the bakery must sell the 50 loaves per day just to break even, the banker will be pleased if the actual sales volume is 150 loaves per day than if it is 57 loaves per day. With sales of 57 loaves per day there is a very thin margin of comfort.

Bankers are more comfortable dealing with businesses that has have considerable margins of safety in which to manoeuvre.

There are three main types of mergers which are as follows

(1) Horizontal merger – where two business in the same activity or subsector link up. For example, the merging of two commercial banks.

(2) A vertical merger – where firms in the same industry but located at different points of the vertical activity chain link up. For example,a brewery merging with a company that operates several bars or liquor stores.

There are also two major subdivisions of vertical mergers namely

(i) Vertical forward or upwards integration-for example , a manufacturer taking over a distribution chain or outlet

(ii) Vertical backwards or downwards-a manufacturer merging with a supplier of raw materials

(3) Conglomerate/Diversification – where a company merges with another in an unrelated industry or activity so there is no carry over of specific capabilities. The case of diversification rests on spreading the risk by not having all your eggs in one basket and the advantages of managing firms as individual strategic business units(SBUs) within a portfolio.

Mergers - rationale

The merger may formalize well-established joint ventures or strategic alliances which may already have been in existence.

The potential partners would have done their homework to ensure that the merger allows them to:

Ø Eliminate unnecessary competition and to harmonize operations; thereby cutting costs focusing attention and energy, and combining to unlock value

Ø Combine resources and skills to the best effect

Ø Offset each other’s weaknesses and augment each other’s strength.

Ø Achieve economies of scale

There are also situations where two or more companies may merge in order to pre-empt a hostile takeover bid of one the parties involved. The hope is that the merged company will be more difficult to attack or that the rationale behind hostile takeover bid will no longer hold water.

However, it is pertinent to note mergers may fail if the following factors are ignored.

Guiding Principles

Having guiding principles that are linked to the merger’s strategic intent. They cannot be a merger just for the sake of it. They must be a strategic intent and guiding principles must be developed based on the strategic intent.

Feedback To Stakeholders

All stakeholders must be given information during the formulation, implementation and finalisation. This ensures that no stakeholder group will be surprised with the final product.

Set stretching targets

Stretching targets will help ensure that the integration team will push as far is possible for cost savings and revenue generation.

Clear Financial Benchmarks

There must be clear financial benchmarks built into the merger implementation plan. A very detailed plan which ignores the financial aspects is like having no plan at all.

Merging cultures

A merger may also involve the merging of two groups of employees whose working cultures will be at variance. Ignoring the cultural aspect will be fatal. It is critical that management set a clear vision that is understood by both sets of employees and there must be ‘buy in’ events which must be held as part of the implementation plan.

A merger must be thoroughly thought through to avoid pitfalls.

This measure is key indicator of productivity and operating efficiency.
This looks at the relationship between a business’s resources (its assets) and its net profit. It is one measure that is sometimes used to gauge management performance. The reasoning behind this is that a consistently high return on the business’s assets requires considerable management skill and ingenuity.
The formula is as follows

Net Profit Before Tax
Total Assets

Net profit before tax is the preferred numerator because it eliminates the distortions that can arise from different tax regimes or different tax strategies.
A low or decreasing ratio may ring alarm bells to your banker as this may indicate a lack of proactive management or even unsustainable operations. Where possible, a low ratio can be remedied by generating more sales per dollar of assets.