BREAKEVEN - WHAT IS IT? DEFINITION: When a business is breaking even it is just earning enough sales revenue to pay for all of its total costs No profit is being made and no loss is being made either SALES REVENUE = money made from sales of products TOTAL COSTS = money that must be paid to cover bills and other expenses

WHY IS IT USED? Banks and lenders will be interested to know if a business is able to breakeven quickly. The longer the time a business takes to make a profit the more risky it is.

JJ’s T-Shirts JJ is considering starting up his own T-Shirt business. He thinks he will sell the T-Shirts for £10 and that his variable costs per T-Shirt will be £4. He needs to calculate the breakeven point using 3 different methods 1.Table 2.Formula 3.Chart

Method 1 – Using a Table OutputSales Variable Costs Fixed Costs Total Costs Profit '000£' Break-even occurs where contribution equals fixed costs = between 6,000 & 7,000 units

Method 2 – Using a formula Breakeven output (units) =FIXED COSTS SELLING PRICE – VARIABLE COSTS Breakeven output =40,000 £10 - £4 Breakeven = 6,666 units

Method 3 – Break-even Chart The following slides lead you through the stages of completing a break-even chart It is unlikely that you will be asked to complete a break-even chart (not enough time!) However, it is important to understand the concepts used in constructing the chart

Break-even chart – Step 1 Sales and costs (£’000) Units of Output (‘000) The first step is to produce two axes: The vertical axis shows the value of sales & costs The horizontal axis shows the output

Break-even chart – Step 2 Sales and costs (£’000) Units of Output (‘000) Fixed costs The next step is to add the fixed cost line. Remember that we assume fixed costs don’t change with the level of output. So the fixed cost line (in red below) is a horizontal line, showing £40,000.

Break-even chart – Step 3 Sales and costs (£’000) Units of Output (‘000) Fixed costs Variable costs Next we add the variable costs. We assume that variable costs vary directly with output. In our example, the variable cost per unit is £4. So variable costs for 1,000 units will be £4,000, and at 5,000 units they will be £20,000. Remember that you only need to plot a couple of points to be able to draw the straight line (in yellow below).

Break-even chart – Step 4 Sales and costs (£’000) Units of Output (‘000) Fixed costs Variable costs Total costs Next step is to add the variable costs to the fixed costs for each level of output. This is important. Remember that to calculate break-even we need to know total costs. The total cost line is shown in green on the chart.

Break-even chart – Step 5 Sales and costs (£’000) Units of Output (‘000) Fixed costs Variable costs Total costs Total sales Having dealt with costs, we can now draw the line for total sales. Remember that we assume that all output is sold for the same selling price (in this case - £10 per unit). So total sales for 2,000 units will be £20,000; 10,000 units will make £100,000 of sales. The total sales line is drawn in blue

Break-even chart – Step 6 Sales and costs (£’000) Units of Output (‘000) Fixed costs Variable costs Total costs Total sales