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Break-Even Level of Output BUSINESS STUDIES IGCSE

The document discusses break-even analysis, which is used to determine the level of output or sales needed to cover total costs. It provides an example break-even chart showing fixed costs, variable costs, total costs, revenue, and the break-even point where total costs and revenue are equal. The document also lists advantages of break-even charts in analyzing profitability and safety margins, and limitations to assume costs are fixed and all output is sold. It concludes by presenting the formula to calculate break-even level of production without a chart.

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Hriday Kotecha
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Download as PDF, TXT or read online on Scribd
94 views

Break-Even Level of Output BUSINESS STUDIES IGCSE

The document discusses break-even analysis, which is used to determine the level of output or sales needed to cover total costs. It provides an example break-even chart showing fixed costs, variable costs, total costs, revenue, and the break-even point where total costs and revenue are equal. The document also lists advantages of break-even charts in analyzing profitability and safety margins, and limitations to assume costs are fixed and all output is sold. It concludes by presenting the formula to calculate break-even level of production without a chart.

Uploaded by

Hriday Kotecha
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Break-even

Break-even level of output is the output that needs to be produced


and sold in order to start making a profit. So, the break-even output is
the output at which total revenue equals total costs (neither a profit nor
loss is made, all costs are covered).
A break-even chart can be drawn, that shows the costs and revenues
of a business across different levels of output and the output needed
to break even.

Example:
In the chart below, costs and revenues are being calculated over the
output of 2000 units.
The fixed costs is 5000 across all output (since it is fixed!).
The variable cost is $3 per unit so will be $0 at output is 0 and $6000
at output 2000- so you just draw a straight line from $0 to $6000.
The total costs will then start from the point where fixed cost starts
and be parallel to the variable costs (since T.C.= F.C.+V.C. You can
manually calculate the total cost at output 2000:
($6000+$5000=$11000).
The price per unit is $8 so the total revenue is $16000 at output 2000.
Now the break-even point can be calculated at the point where total
revenue and total cost equals– at an output of 1000. (In order to find the
sales revenue at output 1000, just do $8*1000= $8000. The business
needs to make $8000 in sales revenue to start making a profit).
Advantages of break-even charts:
• Managers can look at the graph to find out the profit or loss at each level
of output
• Managers can change the costs and revenues and redraw the graph to see
how that would affect profit and loss, for example, if the selling price is
increased or variable cost is reduced.
• The break-even chart can also help calculate the safety margin- the
amount by which sales exceed break-even point. In the above graph, if the
business decided to sell 2000 units, their margin of safety would be 1000
units. In sales terms, the margin of safety would be 1000*8 = $8000. They
are $8000 safe from making a loss.
Margin of Safety (units) = Units being produced and sold – Break-
even output
Limitations of break-even charts:
• They are constructed assuming that all units being produced are sold. In
practice, there are always inventory of finished goods. Not everything
produced is sold off.
• Fixed costs may not always be fixed if the scale of production changes. If
more output is to be produced, an additional factory or machinery may be
needed that increases fixed costs.
• Break-even charts assume that costs can always be drawn using
straight lines. Costs may increase or decrease due to various reasons. If
more output is produced, workers may be given an overtime wage that
increases the variable cost per unit and cause the variable cost line to
steep upwards.

Break-even can also be calculated without drawing a chart. A


formula can be used:

Break-even level of production =Total fixed costs/ Contribution per unit


Contribution = Selling price – Variable cost per unit (this is the value
added/contributed to the product when sold)
In the above example, the contribution is $8 -$3 =$5, so the break-
even level is:
$5000/$5 = 1000 units!

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