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Break Even Analysis

Break Even Output


The level of output at which total sales revenue is equal to total costs of production When costs are greater than revenue the firm makes a loss When costs are less than revenue the firm will make a profit What happens when costs = revenue? The firm will just break even

Assumptions
Fixed costs must be paid regardless of level of output Variable costs increase with output but at a constant rate, so if 1 unit cost 5 then 10 units will cost 50 Every Unit of output produced is sold Selling price remains constant regardless of units sold

Break-even analysis
is a method for finding out the minimum level of sales necessary for a firm to just start to make a profit

Calculating Break Even


3 Methods
Using a table showing revenue and costs over a range of output levels Using a formula Using a graph

Table
Units of output (000s) Sales Revenue Fixed Costs Variable Costs Total Costs Profit

(000s)

(000s)

(000s)

(000s)

(000s)

0 1

0 15

50 50

0 5

2
3 4 5

30
45 60 75

50
50 50 50

10
15 20 25

6
7 8 9

90
105 120 135

50
50 50 50

30
35 40 45

10
11 12

150
165 180

50
50 50

50
55 60

Formula
Contribution per unit = selling price direct cost per unit This shows the amount that each unit contributes towards fixed costs Break even = Fixed Costs () contribution per unit ()

Sales Revenue/Costs
200

Graph
Total Revenue

150 Break Even Point 100 Fixed Costs 50 Break even output 0 Total Costs

2000

4000

6000

8000

10000

12000

Units of output

Break-even analysis
is based on: costs prices production/sales levels.

Definitions
Break-even quantity (BEQ) The level of sales or output where costs equal revenue and the firm is therefore making neither a loss nor a profit. Break-even revenue (BER) The level of sales revenue being earned by the firm at the break-even level of output. Break-even point (BEP) The position where TC and TR lines cross.

You need to be able to draw the lines


Total Revenue(TR) = Number of items sold x their price Total costs (TC) = FC + VC(x) At break-even TR = TC or P(x) = FC + VC(x) So BEQ = FC/(P - VC)

Drawing a diagram from scratch


FIRST work out BEQ Step 1 Extract the data FC 480,000 per month. VC: 60 per unit Price: 120 per unit

Step 2 Calculate the BEQ


The equation - BEQ = FC / (P - VC) 480,000 per month / (120 - 60 per unit) = 480,000/60 = 8,000 units per month

Step 3 Fix the X Axis (capacity)


If you are given a maximum capacity, use that figure. If not, double the break-even quantity is a good guide figure, or 16,000 units in this case.

Revenue is usually the greatest figure. In this case the maximum revenue is 16,000 x 120 = 1.92 million (price per unit x maximum possible sales).

Step 4 Fix the Y Axis (revenue and costs)

Step 5 Plot the TR Axis

Step 6 Add the FC point

FC

Step 7 Add the TC Line

FC

Remember
Add labels to the two axes and to give the chart a title