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Break-Even Analysis

This document provides an overview of break-even analysis. It defines break-even analysis as the point at which total revenues equal total costs, resulting in neither profit nor loss. It identifies the key components as fixed costs, variable costs, total costs, and break-even point. It also provides the formula for calculating break-even point. An example is given of a sports shoe business with information on fixed costs, variable costs per unit, selling price per unit, and maximum output. The document explains how to construct a break-even chart and interpret it to identify the break-even point, profit/loss areas, and maximum profit. It outlines some uses of break-even analysis including identifying production levels for breaking even or maxim

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Muhammad Measum
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Download as DOCX, PDF, TXT or read online on Scribd
48 views

Break-Even Analysis

This document provides an overview of break-even analysis. It defines break-even analysis as the point at which total revenues equal total costs, resulting in neither profit nor loss. It identifies the key components as fixed costs, variable costs, total costs, and break-even point. It also provides the formula for calculating break-even point. An example is given of a sports shoe business with information on fixed costs, variable costs per unit, selling price per unit, and maximum output. The document explains how to construct a break-even chart and interpret it to identify the break-even point, profit/loss areas, and maximum profit. It outlines some uses of break-even analysis including identifying production levels for breaking even or maxim

Uploaded by

Muhammad Measum
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Topic: Break-even analysis:

Objectives:
You should be able to….

 Construct, complete, or amend a simple break-even chart.


 Interpret a given break-even chart and use it to analyze a situation.
 Calculate break-even output from provided data.

Introduction:

A break-even analysis is a financial calculation used to determine the point at which a business's
total revenues equal its total expenses, resulting in neither profit nor loss.
I.e. it's the point at which a business "breaks even" and covers all its costs. Beyond this point, every
additional sale or unit produced contributes to profit.

Key components and concepts involved in break-even analysis:

 Fixed Costs: These are the costs that do not change with the level of production or sales.
Examples include rent, insurance, salaries of permanent staff, and equipment depreciation.

 Variable Costs: These costs vary directly with the level of production or sales. Examples include
raw materials, direct labor, and sales commissions.

 Total Costs: The sum of fixed and variable costs is the total cost for a given level of production.

 Break-Even Point (BEP): The break-even point is the level of production or sales at which total
revenues match total costs. At this point, the business neither makes a profit nor incurs a loss.

 Break-Even Analysis Formula:


The break-even point can be calculated using the formula:
¿ costs
BEP (in units) =
selling price per Unit −Variable cost per unit
Or,
Contribution Margin .
BEP (in currency form e.g. dollars) =
Margin Ratio
The "contribution margin" is the amount that each unit sold contributes to covering fixed costs
and, eventually, generating profit. It is the difference between the selling price per unit and the
variable cost per unit. It represents the portion of each sale that contributes to covering fixed
costs.

1
Drawing a break-even chart.

To draw a break-even chart, we need information about the FC, VC and revenue of a business.
E.g. A sports shoe business has the following information;
- Fixed costs are $5000 per year.
- Variable costs of each pair of shoes are $3
- Each pair of shoes is sold for a price of $8
- The factory can produce a maximum output of 2000 pairs of shoes per year.

To draw the break-even chart, we complete a table like the one below:

Note: There will be no variable costs because there is no output being produced. i.e. no shoes are
being sold and so there also no revenue.

Question: (5 mins)
How were the figures got when total sales where 500 units? Turn to your neighbor and discuss.

2
The information above can be plotted on a graph below:

Note:
 The ‘y’ axis (vertical axis) measures money amounts (costs & revenue)
 The ‘x’ axis (horizontal axis) shows the number of units produced and sold.
 The fixed costs do not change at any level of output.
 The total cost line is the addition of variable costs and fixed costs.

From the graph…….


1. How many pairs of shoes should be sold in order to break even?
2. What do the blue and red areas represent on the chart?
3. What is the maximum profit made when maximum output is reached?

Paired Activity 1: (5 mins)

3
Group Activity (3) 2: (5 mins)

Define, calculate and interpret the margin of safety.

Homework
a) Watch the video to define, calculate and interpret the margin of safety
b) Generate your own example and work it out.

Uses/advantages of break-even analysis to make simple decisions.


Individually, use your course books and discuss the uses of the break-even analysis to make
business decisions.

Uses may include:


 Identifying the break-even point of production to know how much to produce in order to break-
even and calculate the maximum profit.
 Managers can read off from the graph the expected profit or loss to be made at any level of
output.
 The analysis can be used to show the impact on profit/loss of certain business decisions. E.g.
what could happen to the break-even point and the maximum output level if the manager decided
to increase the SP to $9 per pair? (see the shoe business earlier discussed)
(Use a graph to answer this). What do you observe?

4
Observations.
- The maximum revenue now rises to $18,000. The break-even point of production falls to 833
units and the maximum profit rises to $7000. Is it a wise decision???
However the manager needs to consider competitor prices too….meaning he may not sale all
the 2000 pairs at $9 each.

 The break-even chart can also be used to show the safety margin. i.e. the amount by which sales
exceed the break-even point.

Limitation of break-even charts.


In pairs, summarize the limitations of break-even charts in your book.
Use your course book as a resource. Be prepared to share your summary with the class.

5
Activity 1: 10 mins

Activity 2: 10 mins

Activity 3: 10 mins

6
Assessment: Try out the exam style questions at home

7
8
Topic: Achieving quality production
Why quality is important and how quality production might be achieved.
Choose your assigned are, read, summarize and prepare to present to class in our next
lesson)
a) What quality means and why it is important for all businesses. (Natasha, Romain)

b) The concept of quality control and how businesses implement quality control. (Laurence,
Aaliya, Mary)

c) The concept of quality assurance and how this can be implemented. (TQM). (Aminat,
Measum, Emmanuel)

Prepare your presentation in any way you want, provided its meaningful

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