By the end of the chapter you
should be able to --- Distinguish between contribution per unit and total
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contribution
Draw a break-even chart
Calculate – BE quantity, profit, margin of safety, target
profit output, target profit, target price
Analyze effects of change in price or cost on breakeven quantity, profit & margin of safety
Examine benefits and limitations of break-even
analysis
Contribution
 Importance concept when determining overall
profitability
 Contribution is not the same as profit
 Contribution per unit
 Price per unit – variable cost per unit
 Total Contribution =Tot. Revenue – Tot. variable costs
 Total contribution = contribution per unit X number
of units sold
Contribution and Profit
 Profit – Total Contribution – Total fixed costs
 Breaking Even
 When a business neither makes a profit nor a loss
 What level of output needed
Break-even Chart
 Fixed costs – paid no matter level of output
 Variable costs – increase with units of production
 Total Revenue – begins from zero; greater # of units
sold, greater revenue
 Break-even point – point where total cost line
intersects with the total revenue line
 Examine Figure 3.3.1
Margin of Safety
 Difference between the break-even level and the actual
(current) level of output
 The range of output over which profit is made
 The greater the safety net, the greater the profit.
 Margin of safety = current output – break-even output
See figure 3.3.2
Calculating break-even quantity
 Using contribution per unit
 Break even Qty = fixed costs / contribution per unit
 Example page 182-183
 Using total costs = total revenue method
 Example – page 183
Profit or Loss
 Any sales that exceed break-even quantity generate
profit
 Sales less than break-even quantity lead to losses
 Profit = Total revenue (TR) – total costs (TC)
Target Profit
 Tar get Profit Output – can be used to determine level
of output needed to earn a given level of profit
 Formula – Target Profit Output ==
 Fixed Costs + Target profit / Contribution per unit
 Look at formula – page 184
Calculating Target Profit
 Example – page 185
 Calculating Target Price
 Break-even Revenue
 Fixed costs / Contribution per unit X price per unit
Effects of changes in price or cost
 Changes in price
 Figure 3.3.4 – page 186
 Changes in Costs
 Increase in fixed costs – Figure 3.3.5
 Increase in Variable Costs – Figure 3.3.6
Benefits of Break-even Analysis
 Easy & visual way to analyze financial position
 At a glance, using the charts, management can
determine profit, loss, margin of safety, etc.
 Formula can be used to give more accurate results
 Changes in price & costs impact profit & loss; can be
compared using the charts
 Analysis can be used as a strategic decision-making
tool
Limitations of break-even
 Assumes all output produced is sold; in reality many
times stock is held
 Assumes all revenue & cost lines are linear. This is not
always the case. Price reductions and discounts
influence the revenue line
 Semi-variable costs aren’t represented on the breakeven chart
 Chart may not be useful in changing or dynamic
business environments – may not reflect changes in
prices, costs or technology
Limitations - continued
 Fixed costs may change at different levels of activity
 Assignment –
 Student Workpoint 3.9