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Break Even Basics Basics

AfirmBreaksEvenifitdoesntmakeaprofitor aloss Inotherwordsprofit=0 Businessesmustmakeaprofittosurvive Tomakeaprofit,incomemustbehigherthan expenditure(orcosts)

Income Costs Profit

50,000 40,000 10,000

Income Costs Loss

50,000 60,000 10,000

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Calculating Break Even Even


Breakevenoccurswhereprofitiszero Forthistohappenthemoneycomingintoabusiness (TotalRevenue)mustbethesameasthemoneyleaving thebusiness(TotalCost) Assuch,thebreakevenpointoccurswhen:

Total Revenue

Total Costs

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Total Revenue (TR) (TR)


Thisisthetotalamountofmoneyafirmreceivesfrom sellinggoodsorservices Itiscalculatedusingthefollowingformula: Total Revenue (TR)

Price per unit

Number of units sold

Forexample,ifafirmsells1sweetfor10p,its totalrevenuewillbe(1x10p)10p Ifthesamefirmsold10sweetsfor10peachit wouldreceiveintotal(10x10p)1.00


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Total Costs (TC) (TC)


Thisisthetotalamountofmoneyafirmspendson makinggoodsorservices Itiscalculatedusingthefollowingformula: Total Cost (TC)

= Total Fixed Costs (FC)

+ Total Variable Costs (VC)

Where:
TotalFixedCosts=Allfixedcostsaddedtogether TotalVariableCosts=Variablecostperunitmultipliedbythe numberofunits

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An Example of Total Costs Costs


Afirmmakes10,000cansofdrink Ithasthefollowingfixedcosts:
1,000rent 5,000Electricity.

Theyalsoknowthatitcosts5ptomakeeverycanof drinkthatitproduces. Totalcostwillbe:


FC(1000+5,000)=6,000 VC(10,000x5p)=500 TC=6,000+500=6,500

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Calculating The Break Even Point Point


Onceafirmknowsits totalrevenueandtotal costsitcancalculate itsbreakevenpoint Thisoccurswhere TR=TC,i.e.whenthe 2figuresarethesame Usethefollowing informationtocomplete thetable:
FC=2000 VC=2perunit Sellingprice=4
Output 0 200 400 600 800 1000 1200 1400 1600 1800 2000 FC VC TC TR Profit

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The Break Even Chart Chart


Itiseasiertoseethisinformationgraphically Thiscanbedoneusingabreakevenchart
e.g.,usingthepreviousfigures:
CostsandRevenue() 8000 7000 6000 5000 4000 3000 2000 1000 200400600800100012001400160018002000 Output Breakevenpoint TC=TR TR

T FI RO

TC

ss o

MarginofSafety FC

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The Margin of Safety Safety


IfafirmisproducingANDsellingmorethanthebreak evenlevelofoutputthenaprofitisbeingmade InthissituationtheyaresaidtohaveaMarginofSafety Thisiseffectivelyasafetynet,andcanbecalculatedas:

Actual Sales

Break Even Output

Soinourpreviousexample,themarginofsafetywould be:
ActualSales=1800units BreakEvenLevel=1000units MarginofSafety=18001000=800
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Using A Formula to calculate The Break-Even Point Point


Creatingagraphtocalculatebreakevenistime consuming Itisquickertousethefollowingformula:
Break EvenPoint FixedCosts
=

(SellingPriceVariableCostPerUnit) 1,200 Break Even Point = 2015


Break = Even Point

ForExample:
FixedCosts VariableCosts SellingPrice 1,200 15 20

240
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Advantages & Disadvantages of Break Even Even


Advantages
Quickandsimple Easytounderstand Helpsspotpotential problems Canassistwhenapplying foraloan

Disadvantages
Itisonlyaforecast! Assumesallproductsare madeANDsold Costsmaychange Notverygoodfor servicesbecauseprices varyenormously

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