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Break-Even: Learning Objectives

The document provides an overview of break-even analysis, including calculating contribution, determining the break-even point using contribution, interpreting break-even charts, and margin of safety. It also discusses the uses of break-even analysis and some limitations.

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sk001
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173 views

Break-Even: Learning Objectives

The document provides an overview of break-even analysis, including calculating contribution, determining the break-even point using contribution, interpreting break-even charts, and margin of safety. It also discusses the uses of break-even analysis and some limitations.

Uploaded by

sk001
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Break-even

Learning Objectives
1. Calculating contribution (selling price – variable cost per unit).
2. Break-even point (total fixed costs + total variable costs = total
revenue).
3. Using contribution to calculate break-even point.
4. Margin of safety.
5. Interpretation of break-even charts.
6. Limitations of break-even analysis.
Contribution
• Contribution is the
difference between
selling price and variable
costs.
• The difference will
contribute to the total
fixed costs of the
business and the profit.
Contribution per unit and total
contribution
• Unit contribution: It is the
contribution on the sale of
one unit.
Contribution per unit
=
Selling price – Variable cost
Continuation...
• Total contribution: When more than one unit is
sold the total contribution can be calculated.
Total contribution = Total revenue – Total
variable cost
or
Total contribution = Unit contribution × Number
of units sold
Exam tip

• Contribution can be used to calculate the


profit made by a business. The formula
needed is:

Profit = Total contribution – Fixed costs


Determination is key in your
endevours
Break-even point
• The point where total costs (fixed costs +
variable costs) are exactly the same as total
revenue is called the break-even point.
• The level of output a business needs to
produce so that total costs are exactly the
same as total revenue is called the break-
even output.
• It makes neither a profit nor a loss
Calculating break-even using
contribution

Break-even output
=
Fixed costs
Contribution
Break-even chart
• It is possible to identify the break-even
point and break-even output by plotting the
total cost and total revenue equations on a
graph. This graph is called a break-even
chart.
• Output is measured on the horizontal
axis and revenue, costs and profit are
measured on the vertical axis.
Break-even chart for Jack Cadwallader
We need to analyse the break-even
concept
What does the break-even chart show?

• The value of total cost over a range of


output
• The value of total revenue over a range of
output.
• Break-even charts can show the level of
fixed costs over a range of output.
• The level of output needed to break-even.
Continuation...
• The profit at a particular level of output.
• At levels of output below the break-even
output, losses are made.
• At levels of output above the break-even
output, a profit is made.
• The relationship between fixed costs and
variable costs as output rises.
Margin of safety
• Margin of safety – the range of output between
the break-even level and the current level of
output, over which a profit is made.
• What if a business is producing more than the
break-even output? It might be useful to know by
how much sales could fall before a loss is made.
This is called the margin of safety.
• It refers to the range of output over which a
profit can be made.
Continuation...
• Businesses prefer to operate with a large
margin of safety. This means that if sales
drop they still might make some profit.
• With a small margin of safety there is a
risk that the business is more likely to
make losses if sales fall.
Break-even chart showing the margin of safety
for Jack Cadwallader’s business
Uses break-even analysis
• It can be of value in supporting a
business's application for a bank loan
• Break even analysis can be used to
analyse the implications of changing
prices and costs on the enterprise's likely
profitability
• By using break even charts a business
can forecast the effect of varying numbers
of customers on its costs, revenues and
profits.
Continuation...
• It is a technique that can be completed
quickly, providing immediate results
• It is a simple technique allowing most
entrepreneurs to use it without the need
for expensive training.
Limitations of break-even analysis

• It assumes that all output is sold, so that


output equals sales, and no stocks are
held which might not happen always.
• The break-even chart is drawn for a given
set of conditions but market conditions do
change.
• If the data is poor and inaccurate, the
conclusions drawn on the basis of the data
are flawed.
Continuation...
• It is assumed that the total revenue and
total cost lines are linear or straight. This
may not always be the case.
• The problem is how to allocate the fixed
costs of the multi-product business to each
individual product.
• Some fixed costs are stepped.Under these
circumstances it is difficult to use break-
even analysis.

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