Break-Even Analysis AS Business Studies
What is Break-Even Analysis A type of analysis that compares a firm’s revenue with its fixed and variable costs to identify the minimum level of sales needed to cover costs.
Look at the table below.
Output (units per week)
Sales Income (ÂŁ per week)
Total Costs (ÂŁ per week)
0 100 200 300 400 500 600
0 4000 8000 12000 16000 20000 24000
10000 11500 13000 14500 16000 17500 19000
How many units does the company have to sell in order to break even? When is the company making a loss? When are they making a profit?
Now complete this table and say what the break even output is just by looking at the figures. Annual sales
Total variable Annual fixed costs (£4 per costs unit)
Total costs
Total revenue (selling price £7 per unit)
0
0
90000
90000
0
16000
64000
90000
154000
112000
32000
128000
90000
218000
224000
48000
192000
90000
282000
336000
64000
256000
90000
346000
448000
80000
320000
90000
410000
560000
The break even output is the number of units a company has to sell to not make a loss and not make a profit…………in other words where income = outgoings!
Calculating Break-Even To calculate the break-even point we need to know; • The selling price of the product • It’s fixed costs • It’s variable costs per unit
Break-even Formula Break Even Point = Fixed Costs รท Contribution per unit
What is Contribution? Contribution looks at whether an individual product (or activity) is helping the business to make a profit. Contribution ignores fixed costs, only considering variable costs. If sales revenue is higher than variable costs it means that the sale of the product is contributing to paying off the fixed costs (will have to be paid regardless of output) or if they have already been covered it will contribute to the profit.
Contribution Formula Contribution per unit = Selling Price per unit – variable cost per unit
Using the table of figures just completed, work out the contribution per unit and the Break-Even Point for the product.
Total Contribution • Companies can also work out the total contribution of all products sold. • Contribution per unit x number or units sold = Total contribution
OR Sales Revenue – Total Variable Costs = Total contribution
Another way to work out profit‌ If you have already worked out, or already been given the total contribution figure, you could work out the profit for the company by just subtracting fixed costs. Profit = Total contribution – fixed costs
Contribution per Unit and Total Contribution An entrepreneur is planning to set up a coffee shop. She predicts that her costs and revenue will be as follows: • Fixed Costs (per week) : £ 595 • Variable Costs : £0.87 per customer • Selling Price (per customer) : £2.60 • Number of customers (per week) 850 Work out the contribution per unit and total contribution as well as the weekly profit.
Drawing a break-even chart Using graph paper draw a break even chart. Use the figures we have been using this lesson to draw 3 lines – Total Costs, Total Revenue and Fixed Costs. Label the Break-even point and state the break-even output. Does this match your calculation?
Margin Of Safety This is the difference between current output and the Break-even output (when the company is in profit!) The current level of output is known as the Selected Operating Point (SOP). For a new business this could be a forecasted figure.
Assumptions of Break-Even • The selling price remains the same, regardless of the number of units sold. • Fixed costs remain the same, regardless of the number of units of output. • Variable costs vary in proportion to output. • Every unit of output that is produced is sold!
Affects of changes in costs and price on the break-even chart. What happens when some of the aspects needed to calculate break-even output change? In our example what happens if; • Variable costs increase by £1 per unit? • Fixed costs decrease by 10%? • Selling Price increases by £2 per unit? Plot a new graph to show these changes. Using both the formula and the graph state the BEP and BEO.
Usefulness of Break-even analysis to start up businesses • Calculate how long it will take to reach the level of output needed to make a profit. • Helps with getting financial support • Simple way of seeing whether a business plan will be profitable. • Helps to plan ‘best case’ and ‘worst case’ scenarios. (Helps assess risk) • Allows a firm to ask ‘what if’ questions.
Strengths of Break-even Analysis • Can show differing levels of profit. • Calculations are quick and easy. • Helps businesses plan for forecasted changes. • Contribution of each product can be calculated.
Weaknesses of Break-even Analysis • May be unreliable if based on forecasts. • Sales unlikely to be the same as output. • Selling price/ variable costs may change as goods are sold/ bought. • Fixed costs may not always be the same.
Units of Output : 500
Fixed Costs : £1200
Total Variable Costs : £3000 Selling Price £11 each 1. Calculate the contribution per unit. (4 marks) 2. Calculate the total contribution from 500 units. (3 marks) 3. Calculate the break-even quantity. (5 marks) 4. How much profit is made if all 500 units are sold? (4 marks) 5. What is the margin of safety if 500 units are sold? (2 marks) 6. Calculate the break-even quantity if the variable costs rise to £7 per unit and the fixed costs increase to £1400. (5 marks)