Break-Even Analysis
Further Uses
Unit 5
Operations Management
Learning Objectives
HL – Use these methods to analyse the effects
of changes in price or cost on break even ,
profit and margin of safety
HL - Calculate the required output level for a
given target revenue or profit
Analyse the assumptions and limitations of
break even analysis
Break Even Analysis
• Can also be used to assist managers in making
key decisions
• Charts can be redrawn showing a potential
new situation – this can then be compared
with the existing position of the business
• 3 examples of further uses of break even
technique
1. A marketing decision
• Impact of the price increase, this will raise the sales
revenue line at each level of quantity sold
Sales Revenue
2
Costs and sales revenue
Sales
Where is the new break even?
0
Units of output
Full
Capacity
2. An operations management decision
• Purchase of new equipment with lower
variable costs, this will lower the variable cost
line at each level of quantity
Costs and sales revenue
Sales
Total cost 2
Fixed costs 2
0
Units of output
Full
Capacity
3. Choices
• Choosing between 2 locations for a new
factory – with different fixed and variable
costs
Target Revenue and Profit
• Adapted version of the break even formula
can be used if the business wants to
determine a target profit level and establish
the level of output required to achieve it
• Formula changes to
Fixed costs + target profit
Target profit level of output =
Contribution per unit
If the target profit is $25,000, fixed costs are $200,000 and contribution per
unit $50
Level of output needed to earn the target profit is
Break Even Revenue
• The amount of revenue needed to cover both
fixed and variable so that the business breaks
even
An evaluation – Usefulness
• Charts are relatively easy to construct and
interpret
• Useful guidelines to management on break even
points, safety margins and profit / loss levels at
different rates of output
• Comparisons can be made between different
options by constructing new charts to show
changed circumstances
• Equation produces a precise break even result
• Can be used to assist managers when taking
important decisions
An evaluation - Limitations
• The assumption that costs and revenues are
always represented by straight lines is
unrealistic
TC
SR
FC
BE1
BE2
An evaluation - Limitations
• Not all costs can be conveniently classified
into fixed and variable costs (semi – variable
costs)
• No allowance for stock levels, break even
chart assumes all units produced are sold
(iii) Evaluate the usefulness of using break even charts
(8)