3.3.

Break-even Analysis

 Note:

 Total contribution = Total revenue – Total variable cost

 Contribution per unit = Price per unit – Variable cost per unit
 Break-even analysis
 BEQ is quantity when all are equal
 Break-even point
 Intersection of Total Cost and Total Revenue in a Break Even Chart
 Margin of safety
 Shows how much demand exceeds or fails to exceed BEQ
 Sales volume (Projected Demand) – BEQ
 Evaluate degree of risk based on demand for a product
 Can be expressed as a percentage of demand
 Target profit and revenue
 Can be used to calculate level of sales needed to attain a certain profit
 Ignores other factors that affect profit:
 Different pricing throughout time
 Level of demand is subject to change
 Profit depends on risk
 Innovation and luck – prediction aren’t always followed
 Must consider:
 Pricing strategies (penetration pricing, market skimming, etc.)
 Price elasticity
 Break-even is when total costs equal total revenue
 Helps to tell whether a good can be financially worthwhile and the level of profit
a business is likely to earn
 Break-even quantity
 Minimum level of sales before the firm could break even
 When Total revenue  = Total fixed cost + [Total variable cost x Quantity]

 Break-even chart
 Title : Break Even Analysis for Company XYZ
 Label Axes:
 X-axis is output
 Y-axis is Revenue/Cost (label currency as well)
 Determine max. output and mark it, as well as revenue from this level of output
 If maximum isn’t given, make it twice the BEQ
 Determine BEQ and draw a vertical line at that point
 Mark the revenue gained from this quantity on the line (Break Even Point)
 Draw Total Fixed Cost line
 Draw Total Cost line
 starts at TFC at x=0, intersects the BEP
 Draw Total Revenue line
 starts at (0,0), intersects BEP
 Limitations
 Makes several assumptions:
 Fixed costs must be paid regardless of output
 Variable cost increases linearly
 Ignores economies of scale
 Sales revenue increases linearly
 Ignores discounts for large orders and price discrimination
 Assumes only one product is sold
 Every unit of output is sold
 Selling price is constant regardless of units sold
 Provides a static model (e.g. production costs can change)
 Depends on reliability of data
 Other factors can have an effect (e.g. competitors, staff motivation)
 Only suitable for single product firms