Finance - Break Even

Explain what is Break-Even Analysis

Enables a business to calculate the no. of units it must produce and sell to cover all its costs.

Break-Even Formula 

           Break-even = Fixed Costs / Contribution (selling price - variable costs)

Fixed Costs

Costs that aren't affected by the quantity of goods produced or sold. Called 'fixed' because don't alter.

Variable Costs 

They change with output, they increase and decrease with output and are directly related to production E.G. Raw Materials

Margin of Safety 

Thsi is the difference between what the firm is currently producing and teh break-even point. The Margin of Safety can be measured in both units and revenue 

Margin of Safety Formula 

Margin of Safety = Max or Current Output - Break-Even Point

Importance of Break-Even Point 

• It shows the amount of sales required to make a profit which can provide a target for staff and management to aim for which should be motivational.
• It shows the price which needs to be charged for goods which can help with planning for the business.
• It shows the level of costs which the business can bear, this should mean the business bears in mind its costs and tries to be as efficient as possible as could reduce variable or fixed cost and even then lower the breakeven point.

 Importance of Margin of safety 

• Having a margin of safety means that a good level of sales is being achieved   It ensures that the business is profitable. If they don’t have a margin of safety they are making a loss 
• A higher Margin of Safety reduces the risk of business losses. Can set targets to reach a good level of margin of safety
• To increase margin of safety: increase sales, lower the breakeven output by trying to lower fixed costs, try to increase selling price or lower variable costs