Break-Even Analysis

Useful for: Estimating the future level of output they need to produce in order to break-even Assess the impact of planned price changes Assess how changes in fixed and/or variable costs may affect profit Take decisions on whether to produce products Support applications for loans from banks and other financial institutions Break-Even Analysis

Calculating Break-Even Need Selling price of the product (per unit) Fixed costs (Costs which do not change as output changes) Variable costs per unit (Costs which change as output changes )

The break-even output level can be calculated by the formula: Fixed costs Contribution Contribution = Selling price per unit- variable cost per unit

The amount by which demand can fall before the firm starts making a loss The amount which a business sells in excess of its break-even point Margin of Safety

Stage 1 Calculate the breakeven output using the formula: Fixed costs per month =£2000 Selling price =£5 Variable costs per unit =£3 BEP= 2000 = 2000 = 1000 units per month 5-3 2

Stage 2 Multiply the breakeven Output by 2. This will give an indication of the scale, in this case 1000 x 2 = 2000 units. Draw a large square on your graph paper which has a scale of 2000 on the x axis

Stage 3 Draw the total revenue line. This is simply a diagonal line cutting the square in Total revenue

Stage 4 Label the axis. The x axis represents the units of output whilst the y axis represents costs and revenue Costs/ revenue £ Total revenue Output

Stage Costs/ revenue £ Total revenue Output

Stage Costs/ revenue £ Total revenue Output Fixed Costs

Stage Costs/ revenue £ Total revenue Output Plot the breakeven point (1000 units in this example). BEP

Stage Costs/ revenue £ Total revenue Total costs FC Output Draw the total cost line. Total costs cut the y axis at the same point as the fixed cost line. Total costs also go through the breakeven point. BEP

Stage Costs/ revenue £ TR TC FC Output Show area of profit (where total revenue line is above total costs line) and area of loss (where total costs line is above total revenue line). BEP Loss Profit

Stage Costs/ revenue £ TR TC FC Output If an existing output level is given, eg 1500 units, show the margin of safety. BEP Loss Profit Margin of safety

Factors Influencing Break-Even External –A recession can reduce demand –A price war may force a price cut –Variable costs may be pushed up due to inflation Internal –Employing extra sales staff –Price increase –Replacement of labour by automation

Target Profit To earn a target profit in units Fixed Cost + Target Profit Contribution per Unit