Breakeven Analysis
Breakeven Analysis
This is a technique used in budget planning and it provides information about
expected future costs and revenues.
Its key features are:
1. Fixed Costs: the costs that stay the same when extra units are produced. They
are not linked directly to production, e.g. Rent, insurance premiums etc.
2. Marginal (or variable) Costs: the costs that increase when you produce extra
units, i.e. the costs of production, e.g. Materials, labour, variable overheads
such as energy, etc
3. The contribution is the difference between the selling price and the cost price
of a unit. It goes towards covering the fixed costs and then becomes profit.
4. The Breakeven Point is the amount of goods at which the contribution equals
the fixed costs. To find the Breakeven Point in units:
Breakeven Point =
Total Fixed Costs
Contribution of a unit
It can be expressed in money as well. Multiply the selling price by the
breakeven point.
5. The Margin of Safety is the difference between the budgeted level of activity
and the breakeven level.
Example:
A firm has the following estimates for its products
Budgeted output
16,500 units
Fixed Costs
€52,000
Variable costs
€5.80
Selling price
€12.00
a) Find the breakeven point in units and euro.
b) What is the margin of safety for this output?
c) What profit would be made by producing and selling 14,800 units?
Contribution: 12.00 – 5.80 = 6.20
Breakeven point: 52,000/6.20 = 8387.01 units
In euro, the breakeven point is 8387.01 X €12 = €100,645, i.e. sales has to reach this
figure before costs are covered.
Margin of safety = 16,500 – 8387 = 8113
Profit = Total selling price – Total cost price – fixed costs = (14,800X12)(14,800X5.80) – (52,000) = 177,600 – 85,840 – 52,000 = €39,740
Walter Fleming
Page 1 of 3
Breakeven Analysis
Breakeven Chart
This is a graph showing the total costs, the fixed costs and the total sales revenue.
The breakeven point is where the total sales line crosses the total costs line.
To draw a breakeven chart
The money is on the Y axis and the number of units produced on the X axis
The fixed costs is a horizontal line
The total costs are a combination of the fixed costs and the variable costs. To draw
it, add the fixed costs to the total variable costs for two values, at zero where the total
variable cost is also zero, and at the budgeted output costs (cost price X budgeted
output).
The total sales revenue is plotted from (0, 0) to the sales revenue from the budgeted
output (selling price X budgeted output)
Example:
A firm makes the following estimates of its products:
Fixed costs
€41,000
Variable Cost
€6.50 per unit
Budgeted output
7,000 units
Selling price
€15.00 per unit
a) Find the breakeven point in units and euro
b) Draw the breakeven chart
c) Calculate the margin of safety at output of 10,000
d) If the selling price drops to €13.50 and the variable cost increases to €7.50
suggest a new breakeven point in units.
Breakeven point = 41000/8.50 = 4824 units and (4824 X 15) = €72,360
Margin of safety at 10,000 units = 10000-4824 = 5176
New breakeven point = 41000/6 =6833
To draw the chart
1) The fixed costs line Draw a horizontal line across from 41,000 ,
2) The total costs line first point = (0,41000)
The second point = (7000, 86500) i.e. 7000X6.5 + 41000
3) The Total Sales Revenue line first point (0,0)
the second point (7000, 105000) i.e. 7000X15
Limitations of Breakeven analysis
1) It only applies to a single product
2) It assumes that the fixed costs remain the same for all production values,
which may not be the case
3) It also assumes that the variable cost stays the same
4) It assumes that the selling price is constant for all levels of output
Walter Fleming
Page 2 of 3
Breakeven Analysis
Drawing a Breakeven Chart
The scale on the X axis is determined by the Budgeted output while that on the Y axis
is found by multiplying the Budgeted Output by the Selling Price.
1. Total Sales revenue Line
Multiply the budgeted output by the selling price. Then plot the point opposite
the budgeted output on the X axis and the answer on the Y axis.
Join this point to the origin.
2. Fixed Costs Line
Draw a horizontal line from the fixed cost value on the Y axis
3. Total Costs Line
Multiply the budgeted output by the variable cost, then add the answer to the
Fixed Costs. Plot the point opposite the budgeted output on the X axis and the
answer on the Y axis.
Join this point to the start of the fixed Cost Line ( the horizontal line)
Walter Fleming
Page 3 of 3