Business Accounting

Business Accounting
RBA1002 & RBA10x2

Study Unit 3:

Straight Line Graphs

And
Break-even Analysis
(Student Notes)

Study Unit 3 – Straight-line Graphs and Break-even Analysis Notes Page 1

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3. Graphs
Graphs are used to show a relationship between two variables: a dependent and an
independent variable. A variable is anything that can be measured and that can
change. Examples include age, weight, mass, speed, prices, wages, interest rates,
income, quantities sold and bought.

The independent variable determines the value of a dependent variable. For

example, the total price of items will depend on the quantity of items purchased, thus
if we wish to determine the total price of say, shoes, that will depend on the quantity
of shoes bought, therefore:
Number of items (quantity) = Independent variable.
Total price = Dependent variable.

The independent variable is drawn on the horizontal axis (x-axis) and the dependent
on the vertical axis (y-axis). Note that the price level is always drawn on the vertical
axis and the quantity on the horizontal axis.

A graph is drawn on a two-dimensional space, called the Cartesian co-ordinate

space. The horizontal line (from left to right) is called the horizontal axis (or x-
axis) and the vertical line (up and down) is known as the vertical axis (or y-axis).
The y-axis is drawn perpendicular to the x-axis, forming a set of axes. The two axes
cross at zero (0), called the origin.

The axes are divided into four squares known as quadrants. In the first quadrant
both x and y are positive and in the third quadrant both x and y are negative. In the
second quadrant x is negative and y is positive and in the fourth quadrant x is
positive and y is negative.

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The set of axes on which a graph is drawn as follows:

y (+)

Vertical Axis

Second quadrant First quadrant

Horizontal axis

x (-) 0 Origin x (+)

Third quadrant Fourth quadrant

y (-)

For the purpose of our study we will work mostly with the first quadrant. Remember
that the independent variable is drawn on the horizontal axis and the dependent
variable on the vertical axis and that the price will always be drawn on the vertical
axis and quantity will be drawn on the horizontal axis.

Dependent
variable Price

Independent variable Quantity

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3.1 Linear Relationships

A linear relationship is a straight-line relationship between the two variables and

the slope is constant.

A linear graph may have a negative linear relationship or a positive linear

relationship. A negative (or inverse) relationship means that the two variables
move in opposite directions. This means that if the one variable increases, the other
variable decreases.

A positive (or direct) relationship means that the two variables move in the same
direction. This means that if the one variable increases, the other variable will also
increase; or if the one variable decreases, the other variable will also decrease.

3.1.1 Drawing a Straight-line Graph

Steps to follow when drawing a straight-line graph:

Step 1: Look at the table/figures given and decide on a suitable interval.

Step 2: Draw a set of axes and label them.

Step 3: Plot each point, work first from the x-axis and find the corresponding value
for the y-axis.

Step 4: Draw a line through each point.

Example 1:

Given the following five observations of variables x and y, draw the graph to
determine its relationship.

x 3 6 9 12

y 1 2 3 4

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Solution

Step 1: Intervals 3 for the x-axis and 1 for the y-axis

Step 2: Draw a set of axes and label them

Step 3: Plot each point. (also indicate the origin)

0 3 6 9 12 x

Find 3 on the x-axis, the corresponding value is 1; therefore find 1 on the y-axis.
Repeat this process for the remaining pairs of variables.

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Step 4: Draw a line through each point.

4 (12;4)

3 (9;3)

2 (6;2)

1 (3;1)

0 3 6 9 12 x

Example 2: Draw a graph to show a relationship between x and y.

x 0 1 2 3 4 5

y 1 2 3 4 5 6

Solution

Follow steps 1 to 4 as in example 1.

…………………………………………………………………………………………………..

…………………………………………………………………………………………………..

…………………………………………………………………………………………………..

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0 1 2 3 4 5 x

3.2 Finding the Slope of a Straight-line Graph

The slope of a graph indicates whether there is a positive or negative relationship

between two variables. It measures the rate of change between two different
variables. In order to calculate the slope of a straight-line graph we need two points
on the curve that is (x1, y1) and (x2, y2) are any two points on the straight line.

change in y Δy
change in x Δx
The slope of the curve is determined by: = or

y2 - y 1
x2 - x 1
=

Example 1:

Given the following five observations of variables x and y, calculate the slope of the
table between the points when x = 3 and when x = 6.

x 3 6 9 12

y 1 2 3 4

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Solution

When x = 3, the corresponding value is y = 1 and when x = 6, the corresponding y

value is 2, the two points are given as (3,1) and (6,2).

2-1
6-3
Slope =

1
3
=

1
3
What does mean? This means that when the value of x changes (in this case it
increases) by 3 units, the value of y will change (in this case it also increases) by 1
unit. Therefore, when the value of x increases by 3 units, then the value of y will
also increase by 1 unit. This indicates a positive (direct) relationship.

Example 2:

Price 2 4 6 8

Quantity 4 3 2 1

Use the table above to find the rate of change (slope) between price and quantity
when the quantity decreases from 3 to 2, the two points are (3,4) and (2,6).

Solution

When quantity is 3, the corresponding price is 4 and when quantity is 2, the

corresponding price is 6, that is (3,4) and (2,6).

Slope =

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What does slope of ………. mean? This means that if the quantity increases by …..
unit, then the price will decrease by R….. OR if the quantity decreases by ….. unit,
then the price will increase by R…... This indicates a …………………… relationship
between price and quantity.

3.3 Using Straight-line Equations to Draw Straight-line Graphs and

Calculating the Slope

The standard format of the equation in a straight-line graph is: y = mx + c

where y = variable that will be represented on the y-axis

x = variable that will be represented on the x-axis

c = intercept on the y-axis (i.e. value of y when x = 0)

m = slope (i.e. the number of units by which y will change if x changes

by one unit)

Example 1:

When income increases by R1, consumption increases by 50c. When income is

equal to R0, consumption is R5. Given the following equation y = 0,5x + 5, draw a
graph to show the relationship between these two variables.

Solution

Steps to follow:

Step 1: Determine the y -intercept. Make x = 0 and solve for y.

y = 0,5(0) + 5

Therefore the y-intercept is 5. Coordinates (0;5)

Step 2: Determine the x-intercept. Make y = 0 and solve for x.

0 = 0,5x + 5
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Therefore the x-intercept is -10. Coordinates (-10;0)

Step 3: Determine the slope of the graph.

Δy
change∈ y
Δx
Slope = change∈ x or

5−0
=
0−(−10)

5 1
= =
10 2

Step 4: Draw a set of axis, label them and divide the axes into intervals.

5 (0;5)

(-10;0)
-10 0 x

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Example 2:
Consider the following equation: y = 2x + 6
a) Draw a graph to show the relationship for this equation.
b) Calculate the slope of this graph.

Solution
(a)
Determine the y -intercept.

……………………………………………………………………………………….....

…………………………………………………………………………………………..

…………………………………………………………………………………………..

…………………………………………………………………………………………..

Coordinates (………. ; ..........)

Determine the x-intercept.

……………………………………………………………………………………….....

…………………………………………………………………………………………..

…………………………………………………………………………………………..

…………………………………………………………………………………………..

Coordinates (………. ; ..........)

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Draw a set of axis, label them and divide the axes into intervals. Plot the
coordinates for the x-intercept and y-intercept and join these two points.

(b)

Determine the slope of the graph.

…………………………………………………………………………………………..

…………………………………………………………………………………………..

…………………………………………………………………………………………..

…………………………………………………………………………………………..

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 Business Accounting

3.4 Break-even Analysis

Break-even analysis is a graphical or algebraic representation of the

relationship between the production quantity/volume, costs, revenue and profit
of an enterprise. The aim is to achieve a certain profit line. This means
analysing the behaviour of revenue (sales), fixed and variable costs when
volumes vary.

The break-even is that production quantity/volume where the total income

from sales (revenue) equals the total costs, therefore no profit or loss is made.

Note: An important assumption in the calculation of the business’s breakeven

point is that all production quantity is sold.

The breakeven analysis is an important instrument for the management of any

business because it can provide the following information:

i) What is the effect on profit if the business increases or decreases

price?
ii) To what extent will profit increase with an increase in production
capacity and sales?
iii) What effect would an increase in the fixed cost (e.g. the addition of
another production plant for the business) have on profit?
iv) What effect would an increase in the variable cost (e.g. an increase in
wages) have on profit?
v) When is the critical sales quantity reached, in other words, the
breakeven quantity (i.e. the minimum number of products to be sold by
an organisation in a given time period. Gives an indication as to the
marketability of the product by comparing the total demand for product
with the breakeven point. The greater the margin by which the demand

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exceeds the break-even point, the more marketable the product would
be).
vi) What sales quantity and production capacity must be maintained to
achieve a predetermined planned profit?

Example 1: Waltons manufactures and sells Lever Arch files. The following
information is available to you:

Selling Price per Lever Arch R60,00

File (P)
Total Fixed Cost (TFC) R400 000
Variable Cost per file (VC) R20,00

The number of Lever Arch files manufactured and sold may vary between 0
and 18 000, in multiples of 2 000.
Q number of Lever Arch files.
FC Fixed cost
TVC Total variable cost
TC Total cost

Construct a Break-even analysis table:

Sales
TVC = TC = Profit = PQ
P Q FC VC/unit Income = P
VC ¿ Q FC + TVC – TC
¿ Q
R60 0 R400 000 R20 R0 R400 000 R0 (R400 000)
R60 2 000 R400 000 R20 R40 000 R440 000 R120 000 (R320 000)
R60 4 000 R400 000 R20 R80 000 R480 000 R240 000 (R240 000)
R60 6 000 R400 000 R20 R120 000 R520 000 R360 000 (R160 000)
R60 8 000 R400 000 R20 R160 000 R560 000 R480 000 (R60 000)
R60 10 000 R400 000 R20 R200 000 R600 000 R600 000 R0
R60 12 000 R400 000 R20 R240 000 R640 000 R720 000 R80 000
R60 14 000 R400 000 R20 R280 000 R680 000 R840 000 R160 000
R60 16 000 R400 000 R20 R320 000 R720 000 R960 000 R240 000
R60 18 000 R400 000 R20 R360 000 R760 000 R1 080 000 R320 000

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The break-even point is where zero profit is made. Therefore the break-even
quantity is 10 000.

3.4.1 Graphical Representation of Break-even analysis

The break-even analysis can be done graphically with the aid of a break-
even

graph.

Total sales income

Sales income/Costs (‘000 Rands)

1 000

PROFIT
800 Total cost

Total
Variable
Cost

600

Total Fixed Cost

400
LOSS

200

0 2 4 6 8 10 12 14 16 18
Production/Sales Quantity (‘000)

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The horizontal axis represents production quantities and sales in units. The
vertical axis shows the costs and sales income in monetary values.

From the break-even graph and table, the following should be noted:

i) Up to production quantity of 10 000 Lever Arch files, the total costs

exceed the total income and therefore a loss is incurred;
ii) At a production quantity of 10 000 Lever Arch files, total cost = total
income. Therefore no profit or loss is made. This quantity is known as
the break-even quantity.
iii) With a production capacity exceeding 10 000 Lever Arch files, a profit
is made. The projected profit at a maximum capacity amounts to
R320 000.

3.4.2 Break-even analysis formula

Instead of using a graphical break-even analysis, the break-even quantity or

the profit or loss projected for different sales quantities can be calculated
algebraically.

The following variables are necessary for an algebraic calculation:

Q = number of units manufactured and sold

TFC = total fixed cost
VC = variable cost per unit
P = selling price per unit
QB = break-even quantity
TVC = VC ¿ Q
TC = TVC + TFC

Selling price per unit - Variable cost per unit = Contribution per unit
Total sales - Total variable cost = Total contribution

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Profit = Total Sales Income – Total Costs

= PQ – TC
= PQ – (TVC + TFC)
= PQ – (VC ¿ Q) – TFC
= Q (P – VC) – TFC
At break-even quantity, profit is zero. To determine the break-even quantity,
QB, set the above equation equal to 0.

QB (P – VC) – TFC = 0
QB (P – VC) = TFC
TFC
QB =
P−VC

¿ cost
Break-even units =
Contribution per unit

Therefore, if you substitute the information given for Waltons in Example 1:

400000
Break-even units = 60−20
= 10 000

To calculate the break-even sales in Rand value, the selling price (P) is
multiplied by the break-even quantity (QB).

¿ Cost
Break-even sales = x price
Contribution per unit
400000
= 60−20 x 60
= R600 000

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Or

Break-even sales = Break-even units x price

= 10 000 x R60
= R600 000

3.4.3 Margin of safety

To calculate the margin of safety in units:

Margin of safety = sales in units - breakeven in units
= 18 000 – 10 000
= 8 000 units

To calculate the margin of safety in Rands:

Margin of safety = margin of safety units x selling price per unit
= 8 000 x R60
= R480 000

3.4.4 Contribution ratio

To calculate contribution ratio:

Total contribution∈ Rands
Contribution ratio = x 100
Sales∈Rands
1080 000−360 000
= x 100
1 080 000
= 66.67%

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Example 2
Buy Better CC provides you with the following information about two of their
products, A and B:

Product A
Total Rands Price per unit Units
Sales R200 000 40 000
Less Variable costs R3
Contribution R2
Less Fixed costs R30 000
Net profit R50 000

Product B
Total Rands Price per unit Units
Sales R180 000 30 000
Less Variable costs R120 000
Contribution R2
Less Fixed costs R40 000
Net profit R20 000

Remember: Only sales, variable costs and contribution have price per unit and units.
All three have exactly the same units, but not the same price per unit.

A fixed cost is a fixed amount – no units or price per unit, just one total.

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2.1 Calculate the break-even for both products in units and Rands

Product A:
¿ cost
Break-even units =
Contribution per unit
30 000
=
2
= 15 000 units

Break-even sales = Break-even units x price

= 15 000 x R5
= R75 000
Product B:
Break-even units = …………………………

= …………………………

= …………………………

Break-even sales = …………………………

= …………………………

= …………………………

2.2 Calculate margin of safety for both products in units and Rands

Product A:
Margin of safety = sales in units - breakeven in units
= 40 000 – 15 000
= 25 000 units

Margin of safety = margin of safety units x selling price per unit

= 25 000 x R5

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= R125 000
Product B:
Margin of safety = …………………………

= …………………………

= …………………………

Margin of safety = …………………………

= …………………………

= …………………………

2.3 Calculate Contribution ratio for both products

Product A:
Total contribution∈ Rands
Contribution ratio = x 100
Sales∈Rands
80 000
= x 100
200 000
= 40%

Product B:
Contribution ratio = .………………………..

= .………………………..

= .………………………..

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