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The break-even point for a product is the point where total revenue received equals the

total costs associated with the sale of the product (TR=TC). [1]A break-even point is
typically calculated in order for businesses to determine if it would be profitable to sell a
proposed product, as opposed to attempting to modify an existing product instead so it
can be made lucrative. Break-Even Analysis can also be used to analyse the potential
profitability of an expenditure in a sales-based business.

Contents
[hide]

• 1 Margin of Safety
• 2 In unit sales
• 3 In Capital budgeting
• 4 Internet research
• 5 Limitations
• 6 References
• 7 Bibliography

• 8 External links

[edit] Margin of Safety


In break-even analysis, margin of safety is how much output or sales level can fall
before a business reaches its break-even point (BEP).[2]

Margin of safety = ((Budgeted sales - break-even sales) /Budgeted sales) x 100%

[edit] In unit sales


If the product can be sold in a larger quantity that occurs at the break even point,then the
firm will make a profit; below this point, a loss. Break-even quantity is calculated by:

Total fixed costs / (selling price - average variable costs).


Explanation - in the denominator, "price minus average variable cost" is the
variable profit per unit, or contribution margin of each unit that is sold.
This relationship is derived from the profit equation: Profit = Revenues - Costs
where Revenues = (selling price * quantity of product) and Costs = (average
variable costs * quantity) + total fixed costs.
Therefore, Profit = (selling price*quantity)-(average variable costs*quantity+total
fixed costs).
Solving for Quantity of product at the breakeven point when Profit equals zero,
the quantity of product at breakeven is Total fixed costs / (selling price - average
variable costs).
Firms may still decide not to sell low-profit products, for example those not fitting well
into their sales mix. Firms may also sell products that lose money - as a loss leader, to
offer a complete line of products, etc. But if a product does not break even, or a potential
product looks like it clearly will not sell better than the break even point, then the firm
will not sell, or will stop selling, that product.

An example:

• Assume we are selling a product for $2 each.


• Assume that the variable cost associated with producing and selling the product is
60 cents.
• Assume that the fixed cost related to the product (the basic costs that are incurred
in operating the business even if no product is produced) is $1000.
• In this example, the firm would have to sell (1000/(2.00 - 0.60) = 715) 715 units
to break even. in that case the margin of safety value of NIL and the value of BEP
is not profitable or not gaining loss.

Break Even = FC / (SP − VC)

where FC is Fixed Cost, SP is selling Price and VC is Variable Cost

[edit] In Capital budgeting


Break even analysis is a special application of sensitivity analysis. It aims at finding the
value of individual variables at which the project’s NPV is zero. In common with
sensitivity analysis, variables selected for the break even analysis can be tested only one
at a time.

The break even analysis results can be used to decide abandon of the project if forecasts
show that below break even values are likely to occur.

In using Break even analysis, it is important to remember the problem associated with
Sensitivity analysis as well as some extension specific to the method:

• Variables are often interdependent, which makes examining them each


individually unrealistic.
• Often the assumptions upon which the analysis is based are made by using past
experience/data which may not hold in the future.
• Variables have been adjusted one by one; however it is unlikely that in the life of
the project only one variable will change until reaching the break even point.
Management decisions made by observing the behaviour of only one variable are
most likely to be invalid.
• Break even analysis is a pessimistic approach by essence. The figures shall be
used only as a line of defence in the project analysis.
[edit] Internet research
By inserting different prices into the formula, you will obtain a number of break even
points, one for each possible price charged. If the firm changes the selling price for its
product, from $2 to $2.30, in the example above, then it would have to sell only
(1000/(2.3 - 0.6))= 589 units to break even, rather than 715.

To make the results clearer, they can be graphed. To do this, you draw the total cost curve
(TC in the diagram) which shows the total cost associated with each possible level of
output, the fixed cost curve (FC) which shows the costs that do not vary with output
level, and finally the various total revenue lines (R1, R2, and R3) which show the total
amount of revenue received at each output level, given the price you will be charging.

The break even points (A,B,C) are the points of intersection between the total cost curve
(TC) and a total revenue curve (R1, R2, or R3). The break even quantity at each selling
price can be read off the horizontal, axis and the break even price at each selling price can
be read off the vertical axis. The total cost, total revenue, and fixed cost curves can each
be constructed with simple formulae. For example, the total revenue curve is simply the
product of selling price times quantity for each output quantity. The data used in these
formulae come either from accounting records or from various estimation techniques
such as regression analysis.

[edit] Limitations
* == Break-even analysis is only a supply side (ie.: costs only) analysis, as it tells you
nothing about what sales are actually likely to be for the product at these various prices.

• It assumes that fixed costs (FC) are constant


• It assumes average variable costs are constant per unit of output, at least in the
range of likely quantities of sales. (i.e. linearity)
• It assumes that the quantity of goods produced is equal to the quantity of goods
sold (i.e., there is no change in the quantity of goods held in inventory at the
beginning of the period and the quantity of goods held in inventory at the end of
the period).
• In multi-product companies, it assumes that the relative proportions of each
product sold and produced are constant (i.e., the sales mix is constant

When dealing with a make vs. buy decision, there are four numbers you need to know:

1. Your volume
2. The fixed costs associated with making (e.g., the tooling that must be bought)
3. The per-unit direct costs of making
4. The per-unit landed cost from a supplier

So, you plug these numbers into a couple of formulas:

CTB = V * LC and CTM = FC + (PUDC * V)

Where,

CTB = Cost To Buy

V = Volume

LC = Supplier's Per Unit Landed Cost

CTM = Cost To Make

FC = Fixed Costs (of making)

PUDC = Per Unit Direct Cost (of making)

If CTM exceeds CTB, then it is more financially desirable to buy. If CTB exceeds CTM,
the opposite is true. Practice by using the Excel template at
http://www.NextLevelPurchasing.com/make.xls .

Make/buy decisions aren’t just about numbers, though.

Questions you absolutely must consider include:

• Is this the organization’s core competency?

• Could we be harmed by disclosing proprietary information?

• What will be the impact on quality or delivery?

• What additional risks would we be facing?

• How irreversible is the decision?

When dealing with a make vs. buy decision, there are four numbers you need to know:

1. Your volume
2. The fixed costs associated with making (e.g., the tooling that must be bought)
3. The per-unit direct costs of making
4. The per-unit landed cost from a supplier

So, you plug these numbers into a couple of formulas:

CTB = V * LC and CTM = FC + (PUDC * V)


Where,

CTB = Cost To Buy

V = Volume

LC = Supplier's Per Unit Landed Cost

CTM = Cost To Make

FC = Fixed Costs (of making)

PUDC = Per Unit Direct Cost (of making)

If CTM exceeds CTB, then it is more financially desirable to buy. If CTB exceeds CTM,
the opposite is true. Practice by using the Excel template at
http://www.NextLevelPurchasing.com/make.xls .

Make/buy decisions aren’t just about numbers, though.

Questions you absolutely must consider include:

• Is this the organization’s core competency?

• Could we be harmed by disclosing proprietary information?

• What will be the impact on quality or delivery?

• What additional risks would we be facing?

• How irreversible is the decision?

PLANT LOCATION

Qualitative Factors

1. Local infrastructure

2. Worker education and skills

3. Product content requirements

4. Political and economic stability

Quantitative Factors

1. Labor cost
2. Distribution

3. Facility costs

4. Exchange rates

Plant Location Methods

A. Center of Gravity Method

Retail Store Number of containers


shipped/month

Cincinnati 400

Knoxville 300

Chicago 200

Pittsburgh 100

New York 300

Atlanta 100

Formula:

B. Factor Rating

1. Develop a list of relevant factors

2. Assign a weight to each factor to reflect its relative importance

3. Develop scale
4. Have management score each location

5. Multiply score by weight and total

6. Make recommendation, considering


results of qualitative approaches also.

After location is selected, the layout has to be determined.

Process(job-shop) - similar equipment or functions are grouped together

Product (flow-shop) - one


in which equipment or
work processes are
arranged according to
progressive steps by
which product is made.

PLANT LOCATION

Qualitative Factors

1. Local infrastructure

2. Worker education and skills

3. Product content requirements

4. Political and economic stability

Quantitative Factors

1. Labor cost

2. Distribution

3. Facility costs

4. Exchange rates

Plant Location Methods

A. Center of Gravity Method


Retail Store Number of containers
shipped/month

Cincinnati 400

Knoxville 300

Chicago 200

Pittsburgh 100

New York 300

Atlanta 100

Formula:

B. Factor Rating

1. Develop a list of relevant factors

2. Assign a weight to each factor to reflect its relative importance

3. Develop scale

4. Have management score each location

5. Multiply score by weight and total

6. Make recommendation, considering


results of qualitative approaches also.

After location is selected, the layout has to be determined.


Process(job-shop) - similar equipment or functions are grouped together

Product (flow-shop) - one


in which equipment or
work processes are
arranged according to
progressive steps by
which product is made.