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Monday, January 23, 2006

Forecasting 501

In my MBA program, they must have been frightened to send graduates out on the first job before they mastered break even point analysis. We covered break even points in microeconomics, cost accounting, advanced cost accounting, finance, analytical techniques, and marketing. Once in awhile, linear regression would pop up in an operations research course. Regression was rare compared to break even points.

When I got into the real world, I noticed people really did want to know their break even sales level. I also found the simple puzzle of fixed costs, selling price and variable cost per item were tougher to define. Menus were loaded with lots of items. There were no simple answers to the selling price point. Luckily, I remembered my linear regression techniques. In fact, my HP programmable calculator could handle regression fits in minutes. No need to know the selling price.

If you regress labor costs against sales, the curve will yield the fixed cost and the variable cost (as a % of sales). If your food cost % is consistent, throw it into the variable cost bucket. Run another regression curve fit for all other costs. Split the fixed component (intercept) and variable % (slope) and your done.

The break even point in a restaurant with $1,000,000 in fixed costs, a 30% food and beverage cost, and 30% variable cost (labor and other) equals $2,500,000. Be careful of the lease agreement you sign. Good help is hard to find and the high cost of gas is impacting food cost negatively.

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