Break-Even Analysis
.
3 22
Terminology

Sales Revenue / Income – The amount of money a company
takes from selling goods or services.
– Quantity sold x Sale price of each item

Costs / Expenditure – The money that businesses spends
while they trade.
– There are fixed, variable and total costs

Profit (or loss). The amount of money a business makes (or
loses) from carrying out their trade.
– Sales Revenue – Total Costs.
3.22 Calculating a break-even point
The basics of break-even analysis 1
 Businesses must make a profit to survive
 To make a profit, income must be higher than
expenditure (or costs)
Income
Costs
£50,000
£40,000
Income
Costs
£50,000
£60,000
Profit
£10,000
Loss
£10,000
3.22 Calculating a break-even point
The basics of break-even analysis 2
There are two types of costs:
 Variable costs increase by a step every time
an extra product is sold (eg cost of ice cream
cornets in ice cream shop)
 Fixed costs have to be paid even if no
products are sold (eg rent of ice cream shop)
3.22 Calculating a break-even point
Examples of costs
These vary, depending upon the type of business.
Typical costs include:
 Variable: materials, labour, energy
 Fixed: rent, business rates, interest on loans,
insurance, staff costs (e.g. security)
3.22 Calculating a break-even point
The break-Even Point
 Variable costs + fixed costs = total costs
 When total costs = sales revenue,
– This is called the break-even point,
– eg
–
total costs = £5,000
–
total sales revenue = £5,000
 At this point the business isn’t making a
profit or a loss – it is simply breaking even.
3.22 Calculating a break-even point
Why calculate break-even?
Tom can hire an ice-cream van for an afternoon
at a summer fete. The van hire will be £100 and
the cost of cornets, ice cream etc will 50p per
ice cream.
Tom thinks a sensible selling price will be £1.50.
At this price, how many ice-creams must he sell to
cover his costs?
Calculating this will help Tom to decide if the idea
is worthwhile.
3.22 Calculating a break-even point
Calculating Costs and Revenues
Units/
Quantity
Variable
Cost (0.5)
Fixed Cost
(100)
Total Cost
VC+TC
Sales
Revenue
(1.50)
0
50
100
150
200
250
300
3.22 Calculating a break-even point
Calculating Costs and Revenues
Units/
Quantity
Variable
Cost (0.5)
Fixed Cost
(100)
Total Cost
VC+TC
Sales
Revenue
(1.50)
0
0
100
100
0
50
25
100
125
75
100
50
100
150
150
150
75
100
175
225
200
100
100
200
300
250
125
100
225
375
300
150
100
250
450
3.22 Calculating a break-even point
Drawing a break-even chart 1
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
0
100
200
300
Number sold
3.22 Calculating a break-even point
Drawing a break-even chart 2
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
Fixed Cost
0
100
200
300
Number sold
3.22 Calculating a break-even point
Drawing a break-even chart 3
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
Total Cost
Fixed Cost
0
100
200
300
Number sold
3.22 Calculating a break-even point
Drawing a break-even chart 4
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
Sales Revenue
Total Cost
Fixed Cost
0
100
200
300
Number sold
3.22 Calculating a break-even point
Identifying the break-even point
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
Profit
Sales Revenue
Total Cost
Fixed Cost
Loss
Break-even point
0
100
200
300
Number sold
3.22 Calculating a break-even point
Using a formula to calculate the break-even point
The break-even point =
Fixed costs
(Selling price per unit minus variable cost per unit)
Also known as the Contribution as the amount left is
what contributes to paying off the fixed costs.
3.22 Calculating a break-even point
Applying the formula
Fixed costs
(Selling price per unit minus variable cost per unit)
Tom:
£100
(£1.50 – £0.50)
Contribution is £1.00
per unit
=
100
3.22 Calculating a break-even point
Why the Break Even point may change
Changes in the break even point may happen if:
•
Fixed Costs change
•
Variable Costs change, or
•
The selling price changes.
If Fixed Costs go If Variable costs If Selling price go
go
The break
even point
will go
up
down
up
down
up
down
up
down
up
down
down
up
3.22 Calculating a break-even point
Increase in fixed costs.
Cost/Revenue £
Tom's ice creams
Original B.E.P = 100
If fixed costs go up
to £120.
450
400
350
300
250
200
150
100
50
0
Sales Revenue
Total Cost
Fixed Cost
The B.E.P= 120
£120 .
(1.50-.50)
0
100
200
Number sold
300
The reverse
happens if fixed
costs fall.
3.22 Calculating a break-even point
Increase in variable costs.
Original B.E.P = 100
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
If variable costs go
up to £0.60
Sales Revenue
Total Cost
Fixed Cost
The B.E.P= 112
£100
.
(1.50-.60)
0
100
200
Number sold
300
The reverse
happens if variable
cost falls.
3.22 Calculating a break-even point
Increase in Selling price.
Original B.E.P = 100
Cost/Revenue £
Tom's ice creams
If selling price
goes up to £1.60
450
400
350
300
250
200
150
100
50
0
Sales Revenue
Total Cost
Fixed Cost
The B.E.P= 91
£100
.
(1.60-.50)
0
100
200
Number sold
300
The reverse
happens if selling
price falls.
3.22 Calculating a break-even point
Margin of Safety
 If a business knows a level at which it
would like to sell / produce at it can work
out its Margin of Safety.
 The Margin of Safety is the different
between the BEP and the actual level of
production / sales.
 E.g. If Tom aimed to sell 200 ice creams
he would have a Margin of Safety of 100
as his BEP is 100 ice creams.
3.22 Calculating a break-even point
Margin of Safety – On the BE Graph.
Cost/Revenue £
Tom's ice creams
450
400
350
300
250
200
150
100
50
0
Profit
Sales Revenue
Total Cost
Break-even point
Fixed Cost
Margin
of Safety
Loss
0
100
200
300
Number sold
3.22 Calculating a break-even point
Target Profits
 A business can use the break even formula to
calculate the quantity needed in order to
achieve a target profit.
 Target profit (the profit a business wants to
make) is calculated as follows:
 Fixed Costs + Target Profit = Number of units

Contribution per unit
3.22 Calculating a break-even point
Benefits of Break Even Analysis
 Graph easier to understand.
 Helps in the decision making process.
 Shows level of profit / Costs at different
output / sales levels.
 Can establish margin of safety.
3.22 Calculating a break-even point
Drawbacks of Break Even Analysis
 Can only be used in the short term. All
costs potential change.
 If batch processing used cannot obtain
exact BEP.
 Model only viable for one type of product
/ service at a set price.
 Assumption all output sold. Not always
the case.
3.22 Calculating a break-even point
Contribution / Marginal Costing
 Once the contribution per unit has been
calculated you can also calculate the total
contribution at various levels of output or sales.
Total Contribution =
Contribution per unit x Total Number of sales / output.
E.g. £1 x 200 ice creams = £200 total contribution
3.22 Calculating a break-even point
Contribution / Marginal Costing
 Once the total contribution and fixed costs are
know you can work out the price at a particular
output / sales level.
 Profit = Total Contribution - Fixed Costs
 If 200 ice creams sold, profit would be:

£200
- £100

= £100 profit
3.22 Calculating a break-even point