1. Break-even Analysis

2. Revenues, costs and profits
Richard Repairs – your local garage repair service.
Reminder for November and December trading. Looks OK. Yes?
The more repair jobs he does, the higher his profits. Why?
What would happen if he did fewer?
Estimates for November and December
November
December
A Number of Jobs
100
120
B Price charged per job
£100
C Total revenue = A x B
£10,000
£12,000
D Salaries
£2,000
E Other fixed costs
£1,000
F Total fixed costs = D + E
£3,000
G Variable costs per job
£50
H Total variable cost = A x G
£5,000
£6,000
I Total costs = F + H
£8,000
£9,000
J Profits = C - I

3. Revenues, costs and profits
Looking back at November and December, it was a bad Christmas - perhaps too many people went away
Did he make a profit or loss in November and December. Fill in
Actual
November
December
A Number of Jobs 80 60
B Price charged per job
£100
C Total revenue = A x B
D Salaries
£2,000
E Other fixed costs
£1,000
F Total fixed costs = D + E
£3,000
G Variable costs per job
£50
H Total variable cost = A x G
I Total costs = F + H
J Profits = C - I

4. Break-even
New businesses may not make profits in the first few months or even first year after starting
They will of course make estimates for revenues, costs and profits, based on market research
In particular businesses will want to know how what sales are needed in order to break-even
If Richard has 60 repair jobs he breaks even
More than 60 jobs means he makes a profit
Less than 60 jobs, he makes a loss
Jobs
Revenue
Total Costs 40
£4,000
£5,000 50
£5,500 60
£6,000 70
£7,000
£6,500 80
£8,000

5. Calculating break-even
He broke even in December
Break-even output is the level of output where total revenue equals total costs
This means the minimum sales needed to cover costs.
Output less than break-even means a loss, higher output a profit
How can we calculate the break-even point?
Fixed costs are £3, jobs at £100 means £3,000 revenue. Is this break-even?
Need to cover variable costs as well. Each job brings in £100 in revenue, but adds £50 to costs
So each extra job contributes £50 towards fixed costs. This is calculated as selling price – variable cost per unit
So what might the formula be?
Break-even output =
Fixed costs
Selling price per unit – variable cost per unit

6. Break-even charts

7. Examples
Burger stall opens on Surbiton Crescent. Sells delicious burgers for £1.50. He has to pay £50 each day to Kingston Borough Council, and a further £50 for the cost of his stall. Each burger costs 50p in raw materials and cooking. How many does he have to make to break-even.
Great new local boutique, Jenny’s Jeans, selling designer brand jeans for £40 each. A steal. The fixed costs of the shop are £1,500 per month, and each pair of jeans costs Jenny £15. How many jeans must she sell in a month to break-even?
Draw approximate breakeven charts for above

8. Contribution
The idea behind contribution is that each unit sold contributes to covering fixed costs
If selling price is £2.00 and each unit (say a burger) has variable cost of £0.50, then each extra burger sold contributes £1.50 to paying fixed costs
Contribution per unit is therefore selling price (per unit) minus variable cost per unit
Total contribution measures how much all sales made have contributed towards paying fixed costs
This is measured by number of units sold times contribution per unit
For example 100 burgers sold means a total contribution of 100 x £1.50 = £150
This is the same as total revenues minus total variable costs, which would be 100 x £2.00 minus 100 x £0.50, which is £200 - £50 =£150

9. Margin of safety the amount by which current output exceeds break-even output

10. Usefulness of break-even
First and most basic it enables a business to know what sales it needs to achieve to make a profit
Can estimate profits or losses at different levels of output
Gives margin of safety – how far sales are above break-even
Can show what happens to profits and break-even if:
Fixed costs change
Variable costs change
The business changes its price

11. Fixed costs increase (and nothing else changes)
Break-even output =
fixed costs
selling price per unit – variable cost per unit =
contribution per unit
What happens if:
Fixed costs increase (and nothing else changes)
Then fixed costs ÷ contribution per unit will increase, so break-even output increases. Since contribution per unit is the same, a firm will have to sell more to cover the increased in fixed costs
If fixed costs fall, then break-even output falls
Variable cost per unit increases
Then contribution per unit falls (selling price per unit minus variable cost per unit decreases), so break-even increases. Since the contribution from each unit sold decreases, a firm will need to sell more to cover fixed costs
If the variable cost per unit decreases, then break-even output is lower because contribution per unit is higher so fewer units need to be sold to cover fixed costs
Selling price is decreased
Then contribution per unit decreases (selling price minus variable cost per unit decreases), so break-even output increases. Since the contribution from each unit sold decreases, a firm needs to sell more to cover fixed costs
If the price is increased, then break-even will decrease (because contribution per unit increases so fewer units need to be sold to cover fixed costs)

12. Richard Repairs Fixed costs £3,000 per month Selling price £100
Break-even output =
Fixed costs
Selling price per unit – variable cost per unit =
Contribution per unit
Assume fixed costs increase from £3,000 to £4,000 per month. Break-even will increase to 80 jobs:
£4,000 ÷ (£100 - £50)
= £4,000 ÷ £50 = 80 jobs
Say fixed costs do not change but variable costs increase to £60 per job. Break-even will increase from 60 to 75 jobs:
£3,000 ÷ (£100 - £60)
= £3,000 ÷ £40 = 75 jobs
Say neither fixed costs or variable costs change, but Richard cuts the price to £80 (to get more business), then break-even rises from 60 to 100 jobs:
£3,000 ÷ (£80 - £50)
= £3,000 ÷ 30 = 100 jobs
Richard Repairs
Fixed costs £3,000 per month
Selling price £100
Variable cost per unit £50
Breakeven is therefore:
£3,000 ÷ (£100 - £50) = 60 jobs

13. Weaknesses