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Break-Even Analysis is used to
predict future profits/losses
predict results eg produce Product A or Product
B
Break-Even Point is when Sales Revenue
equals Total Costs
at this point no profit or loss is incurred
the firm merely covers its total costs
Break-Even Point can be shown in graph
form or by use of formulae
Break-Even Analysishttp://www.bized.ac.uk
In order to calculate how profitable a product will be,
we must firstly look at the Costs involved -
There are two basic types of costs a company incurs.
Variable Costs
Fixed Costs
TOTAL COSTS
Total Costs is simply Fixed Costs and Variable Costs
added together.
TC = FC + VC
As Total Costs include some of the Variable Costs then
Total Costs will also change with any changes in
output/sales.
If output/sales rise then so will Total Costs.
If output/sales fall then so will Total Costs.
Break-Even Analysis http://www.bized.ac.uk
Fixed Costs:
Rent: 400
Helper (Wages): 200
Variable Costs:
Flowers: 0.50 per bunch
Selling Price:
Flowers: 2 per bunch
So we know that:
Total Fixed Costs = 600
Variable Cost per Unit = 0.50
Selling Price per Unit = 2.00
SP = 2.00
Break-Even Analysis http://www.bized.ac.uk
VC = 0.50
FC = 600
VC = 2.00
First calculate the Unit Contribution
FC = 300
SP VC = Unit Contribution
5.00 - 2.00 = 3.00
VC = 3.00
First calculate the Unit Contribution
FC = 1,200
SP VC = Unit Contribution
6.00 - 3.00 = 3.00
For example:
J Bannerman sells Golf Clubs. How much profit/loss is
made when 5000 golf clubs are sold?
VC = 10.00
Firstly, calculate Unit Contribution
FC = 24,000
SP VC = Unit Contribution
Sales = 5,000 units
20.00 - 10.00 = 10.00
Now calculate Total Contribution when 5,000 golf
clubs are sold
Unit Contribution x no of units = Total Contribution
10.00 x 5,000 = 50,000
Now calculate Net Profit at 5,000 units
Total Contribution Fixed Costs = Net Profit
50,000 - 24,000 = 26,000
Variable Costs =
So:
SP = 2.50
Fixed Costs =
Break-Even Analysis http://www.bized.ac.uk
Flowers 1.49
SP
Rent= 2.50 1,050
Lets try another example. Paper
Insurance 0.01
200
VC = 1.50
Total FC 1,250
(3/300)
FC = 1,250
Caroline Wilson owns a florist shop. Total VC 1.50
She buys each bunch of flowers for 1.49 and
special wrapping paper for 3 per roll. Each roll
of wrapping paper will wrap 300 bunches of
flowers. Rent of her premises is 1,050 per
month and she pays monthly insurance of 200.
Caroline sells each bunch of flowers for 2.50.
What do we know?
SP = 2.50
Break-Even Analysis http://www.bized.ac.uk
VC = 1.50
Calculate Carolines Break Even FC = 1,250
Another Example
If unit contribution is 10
then 5,500 units will have to be produced in order to
achieve a Total Contribution of 55,000.
Break-Even Analysis
The formulae used so far assumes that Unit
Costs are known ie Unit Selling Price and
Unit Variable Cost
Sales 60,000
Variable Costs 24,000
Fixed Costs 14,000
BEP
FC
Q1 Output/Sales
http://www.bized.ac.uk
BEP
BEP
FC
Q2 Q1 Output/Sales
http://www.bized.ac.uk
Break-Even Chart
TR (p = 1)
Costs/Revenue If the firm chose
TR (p = 2)
TC to set prices lower
VC (say 1) it would
need to sell more
BEP units before
covering its costs
BEP
FC
Q1 Q3 Output/Sales
http://www.bized.ac.uk
Break-Even Chart
TR (p = 2)
Costs/Revenue TC If youunits
Any sell sold
fewer
units than
above Break theEven
Profit VC Breakrepresents
Point Even Point, a
a loss is incurred
Profit
BEP
Loss
FC
Q1 Output/Sales
http://www.bized.ac.uk
Margin of Safety
FC
Q3 Q1 Q2 Output/Sales
LIMITING FACTORS http://www.bized.ac.uk
C A
Demand 10,000 5,000
Labour hrs/unit 3 4
Assumptions Continued
The sales mix of products will remain
constant break even charts cannot
handle multi-product situations
It is assumed that all production will be
sold
The volume of activity is the only
relevant factor which will affect costs
Limitations of Break Even http://www.bized.ac.uk
Analysis
Some costs cannot be identified as precisely
Fixed or Variable
Semi-variable costs cannot be easily
accommodated in break-even analysis
Costs and revenues tend not to be constant
With Fixed costs the assumption that they
are constant over the whole range of output
from zero to maximum capacity is unrealistic
Limitations Continued http://www.bized.ac.uk