1. BUSS 1 Financial planning: using break- even analysis to make decisions

2. Using break-even to make decisions Candidates should be able to: define contribution and contribution per unit calculate break-even construct break-even charts analyse the effect of changing variables on break-even use break-even and contribution to make a decision whether to start a business evaluate the strengths and weaknesses of break-even

3. Break-even and break-even charts Break-even occurs when a firm is making neither a p______ nor a l_____. It is generating enough revenue to c_____ c______, but no more. It occurs when total revenue equals total costs. Break-even charts show variable costs, fixed costs, total costs and revenue. It is usually easier to draw up a table first.

4. Example Draw up a table and use it to create a break-even graph. Find the break-even point. selling price = £10 variable cost per unit = £5 fixed costs = £1000 per month maximum output = 250 units per month

5. Example Number of units Revenue (£10 each) Fixed costs Variable costs (£5 each) Total costs 0 50 100 150 200 250

6. Break-even formula Break-even can also be found by using a formula: Break-even = fixed costs selling price – variable costs per unit So what is the break-even point in the previous example using the formula? E.g. break-even =

7. Safety margin The safety margin is the difference between the current level of sales and the break-even output. On the break-even chart it is the horizontal distance from current sales to the break-even point. It can be calculated as Margin of safety = current sales – break even

8. Advantages of break-even analysis

9. Disadvantages of break-even analysis

10. Common errors with break-even What is wrong with the following statements? ‘Calculating the break-even point will ensure that the firm covers its costs’

11. Common errors with break-even What is wrong with the following statements? ‘As firm Y is 50 units short of break-even output, it should cut the selling price. This will mean that sales will go up by 50 units and they will break-even’

12. Questions 1. Calculate the number of units that would need to be sold to break-even if a firm sells its products for £5 per unit, has variable costs of £2 per unit and fixed costs of £6000 2. If the firm is currently selling 2500 units, what is its safety margin?

13. Contribution Contribution is the amount of money that is left over after deducting variable costs from revenue. The formula is: contribution = selling price – variable cost per unit

14. Contribution example If a firm makes shirts that cost £5 per unit in materials and labour, and can sell them for £12, what is the contribution? If the firm’s fixed overhead costs are £700 per week then how many must it sell to cover these costs? How many must it sell to generate profit?

15. Total contribution total contribution = contribution per unit X units sold Or total contribution = total revenue – total variable costs In the previous example, weekly sales of 300 shirts would generate: total contribution =

16. Calculating profit Profit can be calculated by: Profit = total contribution – fixed costs In the previous example: Profit =

17. Using contribution Contribution is used for: calculating a firm’s break-even point (and safety margin) making pricing decisions to calculate profit quickly firms that make several different products as they can calculate the contribution per product

18. Contribution example A firm sells three products. Complete the table ProductABCTotal sales10025090 variable costs6019580 contribution fixed costs100 Profit All figures are £000s

19. Contribution example - answers ProductABCTotal sales1002500 variable costs601950 contribution fixed costs100 Profit Now complete the table assuming that C makes no contribution. What do you find?

20. Contribution questions 1 - 2 1. Calculate the contribution per unit if a firm sells its products for £8 and pays variable costs of £3 2. What would the firm’s profit be if they had fixed costs of £10,000 and sold 3000 units?

21. Contribution question 3 3. What would happen to total contribution if the following single changes took place: suppliers charge more for materials => the firm sells more products => (a) selling price is increased due to increased demand =>

22. Contribution question 4 4. A firm has sales of 200 units a week at a selling price of £30 each. Its variable costs per unit are £18 and fixed costs are £2000. (a) Calculate its current total contribution per week

23. Contribution question 4 continued (b) A firm has sales of 200 units a week at a selling price of £30 each. Its variable costs per unit are £18 and fixed costs are £2000. Use that information to calculate its profit per week

24. Contribution question 4 continued (c) A price increase of 10% pushes sales down to 190 units. Calculate the new total contribution and the new profit. What is the percentage increase in the firm’s profit caused by the price increase?