Breakeven analysis

Key terms (1) Before we start studying breakeven it is essential that you understand some key terms: Breakeven is the point at which total revenue equals total costs. Breakeven analysis helps businesses make decisions about prices, costs and the level of sales. Turnover or sales revenue is the money a business receives from selling its goods. Total revenue = Price per product x Quantity sold If I charged £20 for each product and sold ten then my total revenue would be £200.

Breakeven analysis Key terms (2) Total costs = Fixed costs + Variable costs Fixed costs are costs that do not change as output changes, e.g. rent. Variable costs depend on the amount a business produces, e.g. the more milkshakes McDonald’s sells, the more ingredients it will need.

Breakeven analysis Key terms (3) Contribution per unit is: Selling price per unit – Variable price per unit Margin of safety is the point at which a firm’s actual sales are greater than its breakeven point.

Breakeven analysis Scenario: AP Sports (1) Andy set up AP Sports in 2012 and his costs and revenues were as follows: Price per unit: £10 Variable cost per unit: £5 Fixed costs: £10 We can lay this out in a table format to help us understand the theory.

Breakeven analysis Scenario: AP Sports (2) Number sold Fixed costs (£) Variable costs (£) Total costs (£) Total revenue (£)

Breakeven analysis Scenario: AP Sports (3) The fixed costs remain constant at £10. Total costs are when fixed costs are added to variable costs. The breakeven point is at two units, as the total revenue equals total costs.

Breakeven analysis The formula method A much quicker way to calculate the breakeven is: Total fixed costs ÷ Contribution per unit

Breakeven analysis Why is breakeven useful? It helps assess the impact of price changes. It helps assess changes in costs. It is a useful planning tool. It is an essential part of any business plan.

Breakeven analysis Problems with breakeven Breakeven is only a forecast. It can change if: the price of raw materials changes the number of competitors changes the current market is volatile and breakeven becomes less predictable

Breakeven analysis Student task (1) Fixed costs: £2,000 per month Variable cost per unit: £50 Price per unit: £100

Breakeven analysis Student task (2) Based on the information on the last slide: 1.Draw a table for the monthly data (going up in units of 10) and try and identify the breakeven figure. 2.Calculate the breakeven using the formula method. 3.Draw a breakeven diagram on graph paper, labelling it as follows: total revenue, total costs, fixed costs, breakeven point