Break -even Analysis

Break -even Analysis

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Break -even Quantity

  • Break -even Quantity= fixed costs/ contribution per unit

 

 

  • Contribution per unit=price per unit- variable cost per unit
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Profit or Loss?

Area of loss= 0 up to the break even quantity

Area of profit= break even quantity +

Margin of Safety= maximum output- break even quantity

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Why bother?

To calculate a target level of revenue: read the given output off the graph OR target level of total revenue/price of product

To calculate a target level of profit: find the VERTICAL DISTANCE between the total costs and total revenue lines that corresponds to the target rate of profit.Then read down the X axis to discover how many units need to be sold in order to make a specific rate of profit.

QUANTITY= (FIXED COSTS+TARGET RATE OF PROFIT)/CONTRIBUTION PER UNIT

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how to make the graph

  • FIXED COSTS= plotted at level given in question
  • TOTAL COSTS= fixed costs=variable costs at the maximum sales level. Join the line to this point from the fixed costs line
  • VARIABLE COSTS= plotted from the 0 to the value of variable costs at the maximum sales output and join up line.
  • TOTAL REVENUE= revenue created if the maximum number of units were sold. This point joint up to the  0 point.
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Limitations of Break-even Analysis

:( Semi-variable costs have to assigned to either fixed or variable costs- this will make the analysis inaccurate.

:( Assumes that a businesses vc per unit is constant and that the price is too. This is not always the case because as sales fall prices may lower and VCs may increase due to DIMINISHING RETURNS- this would make the TC and TR lines curved.

:( All output is not always sold- TR and possible levels of profit are therefore likely to be inaccurate.

:( It can only be applied to one product at a time so it is expensive and time consuming to do it for a whole business.

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