Break-even Analysis

Jibran Hussain

Ineconomics&business,specificallycostaccounting,
thebreakevenpoint(BEP)isthepointatwhichcost
orexpensesandrevenueareequal:thereisnonetloss
orgain,andonehas"brokeneven.
A profit or a loss has not been made, although
opportunity costs have been "paid," and capital has
receivedtheriskadjusted,expectedreturn.

BREAKEVEN ANALYSIS

TOTAL COST CURVES:

COSTS

TOTAL COSTS
VARIABLE COSTS

FIXED COSTS

QUANTITY

AVERAGE COST CURVES:

COSTS

AVERAGE TOTAL COSTS

AVERAGE VARIABLE COSTS
AVERAGE FIXED COSTS

QUANTITY

Break - Even Analysis

BREAKEVEN POINT:
TR = TC
TR = VC + FC
(UNITS)($/UNIT) = (UNITS)($/UNIT) + FC
PRICE
COST

B.E. Point

Fixed Costs

Selling price/unit - Variable Cost/unit

Why calculate breakeven?

Ali
at

can
a

hire

summer

an
.

ice-cream
The

van

van
hire

for

will

an
be

afternoon
Rs100

and

the cost of cornets, ice cream etc

50p per ice cream.
Ali thinks a sensible selling price will be Rs1.50.
At this price, how many ice-creams must he sell to cover his costs?
Calculating this will help Ali to decide if the idea
is worthwhile.

Identifying the break-even point

Profit

Loss
Break-even point

Applying the formula

Fixed costs
(Selling price per unit minus variable cost per unit)

Ali :

100
(1.50 50p)

= 100

Break - Even Analysis (Revenues)

$ of Sales
and Costs

Total Revenue
Line

The slope of the

revenue line is
determined by the
price that you set
for your product
or service.

Sales revenue
when price per
unit is $10.00.

$20
$10
1

Number of units produced and sold

Break - Even Analysis (Revenues)

$ of Sales
and Costs

Total Revenue
Line

The slope of the

revenue line is
determined by the
price that you set
for your product
or service.

$20
Sales revenue
when price per
unit is $5.00.

$10
1

Number of units produced and sold

Break Even Revenue Chart

$ of Sales
and Costs

Total
Revenue

TR = TC
Total Costs

Fixed Costs

# of units produced and sold

Break Even Point
in Units

 PROBLEM:
SELECT A PRICE OF $10

OR

$12 FOR PRODUCT X

FACTS:
FIXED COST = $60,000
VARIABLE COST PER UNIT = $6.00
DEMAND IS LIKELY TO BE:
Q = 14,000 UNITS SOLD @ $10.00
Q = 12,000 UNITS SOLD @ $12.00

BREAKEVEN ANALYSIS EXAMPLE

DEMAND:
14,000 UNITS @ $10
12,000 UNITS @ $12
DEMAND CURVE:

TR (@ $10) = 10 X 14,000 = $140,000

TR (@ $12) = 12 X 12,000 = $144,000

15

PRICE
10

0
0

10

15

QUANTITY (K)

CONTRIBUTION TO FIXED COST PROCESS:

@ $10.00
$60,000 /$4.00 = 15,000 UNITS

@ $12.00
$60,000 / $6.00 = 10,000 UNITS

DEMANDED UNITS:
14,000 UNITS
BREAKEVEN GREATER THAN
DEMAND - LOSE MONEY

12,000 UNITS
BREAKEVEN LESS THAN
DEMAND - MAKE PROFIT

Break-even analysis:
Break-even point
Ali sells a product for $10 and it cost $5 to produce
Unit Variable Cost (UVC) and has fixed cost (FC) of
$25,000 per year
How much will he need to sell to break-even?
How much will he need to sell to make $1000?

Algebraic approach:
Basic equation
Revenues Variable cost Fixed cost = OI

(USP x Q) (UVC x Q) FC = OI
$10Q - $5Q $25,000 = $ 0.00
$5Q = $25,000
Q = 5,000
What quantity demand will earn $1,000?
$10Q - $5Q - $25,000 = $ 1,000
$5Q = $26,000
Q = 5,200

Graphical analysis
Dollars
70,000
60,000
50,000
40,000
30,000
20,000
10,000

Total Cost Line

Total Revenue Line

even point

0
1000 2000 3000 4000 5000 6000
Quantity

Break-

Graphical analysis:
Cont.

Dollars
70,000
Total Cost Line
60,000
50,000
40,000
30,000
20,000
Total Revenue Line
10,000
Break-even point
0
1000 2000 3000 4000 5000 6000
Quantity

Break-even Analysis:
Comparing different variables
Company XYZ has to choose between two
machines to purchase. The selling price is
$10 per unit.
Machine A: annual cost of $3000 with per
unit cost (VC) of $5.
Machine B: annual cost of $8000 with per
unit cost (VC) of $2.

Break-even analysis:
Comparative analysis Part 1
Determine break-even point for Machine A
and Machine B.
Where: V =
SP - VC

FC

Break-even analysis:
Machine A:
v =

$3,000
$10 - $5
= 600 units

Machine B:
v = $8,000
$10 - $2
= 1000 units

Part 1: Comparison
Compare the two results to determine
minimum quantity sold.

Part 1 shows:
600 units are the minimum.
Demand of 600 you would choose
Machine A.

Part 2: Comparison
Finding point of indifference between Machine A and Machine B
will give the quantity demand required to select Machine B over
Machine A.
Machine A
= Machine B
FC + VC=
FC + VC
$3,000 + $5Q = $8,000 + $2Q
$3Q = $5,000
Q = 1667

Part 2: Comparison
Cont.
Knowing the point of indifference we will choose:
Machine A when quantity demanded is between 600
and 1667.
Machine B when quantity demanded exceeds 1667.

Part 2: Comparison
Graphically displayed
Dollars
21,000
18,000
Machine A
15,000
12,000
9,000
Machine B
6,000
3,000
0
500 1000 1500 2000 2500 3000
Quantity

Part 2: Comparison
Graphically displayed Cont.
Dollars
21,000
18,000
Machine A
15,000
12,000
9,000
Machine B
6,000
3,000
Point of indifference
0
500 1000 1500 2000 2500 3000
Quantity

Break-Even Analysis
Costs/Revenue

TR

TR

TC

VC

TheAs
Break-even
point
output
is
Total
revenue
is
Thewhere
totaltotal
costs
The
lower
the
occurs
generated,
the
Initially a by
firm
determined
the
therefore
revenue
equals
total
price,
the
less
firm
will
incur
willcharged
incur fixed
price
and
(assuming
costs
the
firm,
in
variable
costs
steep
the
total
costs,
thesesold
do
the
quantity
this accurate
example
would
these
vary
directly
not depend
on
revenue
curve.
again
this
will
be
haveforecasts!)
to
sell
Q1
to
is
the
with
the
amount
output or sales.
determined
by
generate
sufficient
produced
sum
of FC+VC
expected
forecast
revenue to cover
its
sales
initially.
costs.

FC

Q1

Output/Sales

Costs/Revenue

Break-Even Analysis
TR (p = 3)

TR (p = 2)

TC

VC

If the firm chose

to set price higher
than 2 (say 3)
the TR curve
would be steeper
they would not
have to sell as
many units to
break even

FC

Q2

Q1

Output/Sales

Break-Even Analysis
TR (p = 1)

Costs/Revenue

TR (p = 2)

TC

VC

If the firm chose

to set prices lower
(say 1) it would
need to sell more
units before
covering its costs

FC

Q1

Q3

Output/Sales

Break-Even Analysis
TR (p = 2)

Costs/Revenue

TC

Profit

Loss

VC

FC

Q1

Output/Sales

Break-Even Analysis
Costs/Revenue

TR (p = 3)

TR (p = 2)

Margin of
A
higher
price
safety
shows
how far sales
can
would
lower
fall before
the
breaklosses
Assume
made. If Q1 =
even
point
current
sales
1000
and
Q2
=
and
the
1800,
sales could
at Q2
fall by 800
margin
ofunits
before awould
loss
safety
would be made

TC
VC

widen

Margin of Safety
FC

Q3

Q1

Q2

Output/Sales

Costs/Revenue
High initial FC.
Interest on debt
rises each year
FC rise therefore

FC 1
FC
Losses get
bigger!
TR
VC

Output/Sales

Break-Even Analysis
Remember:
A higher price or lower price does not
mean that break even will never be
reached!
The BE point depends on the number
of sales needed to generate revenue
to cover costs the BE chart is NOT
time related!

Exercise 1:
Company ABC sell widgets for $30 a
unit.
Their fixed cost is$100,000
Their variable cost is $10 per unit.
What is the break-even point using the
basic algebraic approach?

Exercise 1:
Answer
Revenues Variable cost - Fixed cost = OI

(USP x Q) (UVC x Q) FC = OI
$30Q - $10Q $100,00 = $ 0.00
$20Q = $100,000
Q = 5,000

Exercise 2:
Company DEF has a choice of two
machines to purchase. They both make
the same product which sells for $10.
Machine A has FC of $5,000 and a per unit
cost of $5.
Machine B has FC of $15,000 and a per
unit cost of $1.
Under what conditions would you select
Machine A?

Exercise 2:
Answer
Step 1: Break-even analysis on both options.
Machine A:
v = $5,000
$10 - $5
= 1000 units
Machine B:
v = $15,000
$10 - $1
= 1667 units

Exercise 2:
Answer Cont.
Machine A
FC + VC
$5,000 + $5
$4Q
Q

=
Machine B
= FC + VC
Q = $15,000 + $1Q
= $10,000
= 2500

Machine A should be purchased if

expected demand is between 1000 and
2500 units per year.

Summary:
Break-even analysis can be an effective
tool in determining the cost effectiveness
of a product.
Required quantities to avoid loss.
Use as a comparison tool for making a
decision.