GCSE
Business Studies
For first teaching from September 2009
For first award in Summer 2011
Breakeven Analysis
Learning Outcomes
At the end of this unit students should be
able to:
•
•
•
•
•
Calculate the margin of safety.
Explain the term breakeven point;
Distinguish between fixed and variable costs;
Calculate the breakeven point both graphically and by formula;
Sketch and label a breakeven chart; and
Setting the Scene
Breakeven analysis
Breakeven analysis is a technique used by businesses such
as Zoom Airlines to estimate the minimum output they
need to produce and sell in order to survive in the industry.
To conduct a breakeven analysis, firms need to compare
their sales revenue with their total costs over a range of
output and calculate the break even point.
The breakeven point for a company such as Zoom airlines is
the point at which it sells exactly the right number of seats
and other products so that its sales revenue is exactly equal
to its total cost. At the breakeven point the firm makes
neither a profit nor a loss.
Businesses use breakeven analysis to:
•
Calculate how many goods they need to sell to make an
acceptable profit.
Zoom Airlines suspend all flights
•
Transatlantic budget carrier Zoom Airlines has suspended all
flights and is applying to go into administration. Thousands of
passengers due to fly with Zoom have been told to rebook with
other carriers, and to contact credit or debit card issuers about
refunds.
Calculate the level of costs that can be borne by the
company – Zoom airlines calculated that they could not
survive if fuel went above $140 per barrel.
•
Calculate how much they need to charge for their
goods.
•
Calculate how changes in price affect their profits and
break even point.
UK-Canadian Zoom blamed its problems on the “horrendous”
price of jet fuel - which had added over £27m to annual fuel
bills - and the economic slowdown.
The rising cost of oil - which topped $147 a barrel in July - has
led to aviation fuel bills soaring.
“They had based their business model on oil prices of
about $70 or $80,” said Simon Calder, travel editor of The
Independent. “Once it topped $140 they simply could not
survive as they were no longer able to breakeven.”
Zoom, which began flying in 2001, employed 450 staff in
Canada and 260 staff in the UK. It operated flights from
London Gatwick, Glasgow, Manchester, Cardiff and Belfast, as
well as Paris and Rome.
Calculating the breakeven point
To conduct a breakeven analysis and calculate the
breakeven point a firm must first consider its total revenue,
its fixed costs, its variable costs and its total costs.
Total Revenue (TR) is the income the firm receives from
selling its products. It is calculated by multiplying the price
of the product by the quantity sold. For example if Zoom
Airlines sold 1000 seats at £50 each, then its total revenue
is £50,000. On a graph the total revenue curve would slope
upwards from left to right and would start at the origin.
Fixed Costs (FC) are those business costs that are not
directly related to the level of production or output. They
are called fixed since they do change as output levels
change. Business rent and rates are examples of fixed costs
since they will have to be paid whether the firm produces
nothing or produces at full capacity. On a graph the fixed
cost curve would be a horizontal line which would start
above the origin.
Breakeven chart
Variable Costs (VC) are costs which vary directly with the
level of output. If output is zero then variable costs are zero
but as output increases so to do variable costs. An example
of a variable cost for Zoom Airlines would be its fuel costs.
The more seats it sells the more fuel is needed to fly the
plane. Other examples of variable costs include workers
wages and electricity charges. On a graph the variable cost
curve is drawn as a straight line sloping upwards from the
origin.
Total Cost (TC) is calculated by adding the fixed costs and
the variable costs of the business together. On a graph the
total cost curve is a diagonal line which has the same slope
as the variable cost curve, but which starts at the level of
fixed cost and not at the origin. This is because even at zero
output the firm has to pay its fixed costs therefore its total
costs will never fall below its fixed costs.
The following illustrates how these three cost curves are
shown on a graph.
Total
Cost
Total Revenue
& Total Costs
One way to calculate the breakeven point is to draw a
breakeven chart. On a breakeven chart the firm will plot its
total revenue, total cost and fixed cost curves.
The diagram below shows a breakeven chart for a typical
firm. The vertical axis shows the total revenue received from
selling each level of output and the total cost of producing
each level of output. The horizontal axis shows the quantity
of output sold.
TR/TC
Total
Revenue
40
Breakeven Point
20
Fixed
Costs
Loss
Margin of Safety
Variable
Costs
40
Total
Cost
Profit
3
6
Units
Sold (#)
We can see from the diagram above that the breakeven
point (the point where TR =TC) occurs when the firm sells 3
units.
20
Fixed
Costs
3
6
Units
Sold (#)
Activity: Fixed & Variable Costs
In the table below indicate which costs are fixed and which
are variable by placing a tick in the appropriate box.
If actual sales are below this breakeven point then the
firm will be making a loss. If actual sales are above this
breakeven point then the firm will be making a profit.
The actual amount of any profit or loss is shown by the
vertical distance between the total cost and total revenue
curves.
Margin of safety
Cost
Fixed
Mortgage
The margin of safety is the difference between the current
level of output and the breakeven level of output. It
represents the number of units that output can fall by
before the business makes a loss. In the diagram above if
the actual level of output is 6 units then the margin of safety
is 3 units of output.
Rates
Calculating the breakeven point by formula
Telephone
Raw materials
Another way to calculate the breakeven point is to use the
following formula Electricity
Managers’ salaries
Workers wages
Interest payments on loans Advertising
Variable
Total fixed costs
Breakeven point =
Contribution Selling price – variable cost per unit
For example, let’s assume a producer is selling shoes at £30
per pair. He has total fixed costs of £20,000 and his variable
costs per pair of shoes of £5. To calculate the breakeven
point we put this information into the above formula.
£20,000
Breakeven point =
£25 (£30 - £5)
We find that the breakeven point 800 pairs of shoes.
Key Terms
•
The breakeven point is the point at which sales
revenue is exactly equal to total cost. At the
breakeven point the firm makes neither a profit nor a
loss.
•
Total Revenue is the income the firm receives from
selling its products. It is calculated by multiplying the
price of the product by the quantity sold.
•
Fixed Costs are those business costs that are not
directly related to the level of production or output.
Examples include managers salaries and interest
payments on loans.
•
Variable Costs are costs which vary directly with the
level of output. Examples include workers wages and
raw material costs.
•
Total Cost is calculated by adding the fixed costs and
the variable costs of the business together.
•
The margin of safety is the difference between the
current level of output and the breakeven level of
output.
Activity: Pete’s Pizza Slices
Peter Smith has just opened his pizza slice shop in Belfast.
He wants to calculate how many pizzas he will have to sell
each month in order to breakeven. He has calculated his
monthly fixed costs to be £2,000 and his variable costs to
be £0.20 per pizza slice. Pete sells his pizza slices for £1 per
slice.
1.
Using the information above complete the following
table. The first row is done for you.
Number Total
Fixed Variable Total Profit
of pizza revenue costs costs
costs /Loss
slices sold
(TR-TC)
0
0
2000
0
2000
500
1000
1500
2000
2500
3000
3500
2. -2000
Use the information in the table above to plot a
breakeven chart. On this chart you should clearly
label:
•
The vertical and horizontal axis.
•
The TR, TC and FC curves.
•
The breakeven point.
•
The area of profit and loss.
3. Calculate the margin of safety if Pete sells 3,500 pizza
slices each month and put it on the graph.
4. Use the formula given in the notes above to calculate
how the breakeven point and the margin of safety
would change if Pete increased his price to £1.20 per
slice.
Revision questions
1.
Explain the difference between fixed and variable
costs.
2.
Explain what is meant by the breakeven point.
3.
Give 3 reasons why a firm would conduct a breakeven
analysis.
4.
Sketch and label a breakeven chart for a typical
business.
5.
Explain the difference between a profit and a loss.
6.
Explain what is meant by the margin of safety.