The Break-Even Point

The break-even point is that quantity

of output where total revenues equals
total costs : that is, where the
operating income is zero.
 COST-VOLUME-PROFIT ANALYSIS
Abbreviations

USP = Unit selling price

UVC = Unit variable costs
UCM = Unit contribution margin (USP-UVC)
CM% = Contribution margin percentage (UCM/USP)
FC = Fixed costs
Q = Quantity of output units sold (and manufactured)
OI = Operating Income
TOI = Target operating income
TNI = Target net income
 CHAPTER 3
Objective 3 COST-VOLUME-PROFIT ANALYSIS
methods for determining break- even point

1. Equation method:
Cost Accounting: A managerial emphasis

Revenues – Variable costs – Fixed Costs = Operating Income

(USP*Q) – (UVC*Q) – FC = OI

Provides the most general and easy-to-remember

approach
Example:
Variable cost=120$/unit Sell price =200$/unit
Fixed cost=2000$
$200Q - $120Q -$2000= $0 $80Q= $2000
Q= $2000/$80 Q= 25 units
 CHAPTER 3
COST-VOLUME-PROFIT ANALYSIS
2.Contribution margin method:
It uses the concept of contribution margin to rework the
equation method.
(USP*Q) – (UVC*Q) – FC = OI

By rewriting,
(USP – UVC) * Q = FC + OI
UCM*Q = FC + OI
Q = (FC +OI)/UCM
At break-even, OI=0, therefore:
Q = FC /UCM

Break-even no. of units = Fixed costs/Unit contribution

margin
 CHAPTER 3
Objective 3 COST-VOLUME-PROFIT ANALYSIS

Substituting,

Break-even no. of units = Fixed costs/Unit contribution

margin
Cost Accounting: A managerial emphasis

Break-even no. of units = $2000/$80 per unit = 25 units

Calculating break-even revenues,

Break-even in revenue dollars = Break-even no. of units X USP

= (FC*USP)/UCM
= FC/(UCM/USP)

Since, CM% = UCM/USP = FC/CM%

= $80/$200 = 40% = $2000/40%
Break-even in revenue dollars = $5000
 Y
3. Graph method:
TR
Revenue and Costs

Profits
TC
Break Even Point

TVC

TFC
Loss

X
0 Q Output
 Y
TR
Revenue and Costs

Profits
Break Even Point TC

TFC
Loss

X
0 Q Output
Diagram of Break Even Point
 CHAPTER 3
Objective 3 COST-VOLUME-PROFIT ANALYSIS

Cost-Volume-Profit Graph for Do-All Software

$14,000.00
Operating
Cost Accounting: A managerial emphasis

$12,000.00 Income area

$10,000.00 Break-even point

Operating Income

$8,000.00

$6,000.00

$4,000.00

$2,000.00
Operating Loss
$0.00 area
0 5 10 15 20 25 30 35 40 45 50 55 60
Units Sold
EXAMPLE

• John sells a product for $10 and it

cost $5 to produce (UVC) and has
fixed cost (FC) of $25,000 per year

• How much will he need to sell to

break-even?

• How much will he need to sell to

make $1000?
1. Equation method:

Revenues – Variable cost – Fixed cost = OI

(USP x Q) – (UVC x Q) – FC = OI
$10Q - $5Q – $25,000 = $ 0.00
$5Q = $25,000
Q = 5,000

What quantity demand will earn $1,000?

$10Q - $5Q - $25,000 = $ 1,000
$5Q = $26,000
Q = 5,200
2.Contribution Margin Method

(USP – UVC) x Q = FC + OI
Q = FC + OI
UMC
Q = $25,000 + 0
$5
Q = 5,000
What quantity needs sold to make $1,000?
Q = $25,000 + $1,000
$5
Q = 5,200
3.Graphical Method:

Dollars
70,000
60,000 Total Cost
Line
50,000
40,000
30,000
20,000
Total Revenue
10,000 Line
Break-even point
0
1000 2000 3000 4000 5000 6000
Quantity
Graphical Method :Cont.

Dollars
70,000
60,000 Total Cost
Line
50,000
40,000
30,000
20,000
Total Revenue
10,000 Line Break-even point
0
1000 2000 3000 4000 5000 6000
Quantity
Break-even Analysis:
Comparing different variables
• Company XYZ has to choose
between two machines to purchase.
The selling price is $10 per unit.

• Machine A: annual cost of $3000 with

per unit cost (VC) of $5.

• Machine B: annual cost of $8000 with

per unit cost (VC) of $2.
Break-even analysis:
Comparative analysis Part 1
• Determine break-even point for
Machine A and Machine B.

• Where: V = FC
SP - VC
Break-even analysis:
Part 1, Cont.

Machine A:
v = $3,000
$10 - $5
= 600 units
Machine B:
v = $8,000
$10 - $2
= 1000 units
 Part 1: Comparison

• Compare the two results to

determine minimum quantity sold.

• Part 1 shows:
– 600 units are the minimum.
– Demand of 600 you would choose
Machine A.
Part 2: Comparison

Finding point of indifference between

Machine A and Machine B will give the
quantity demand required to select
Machine B over Machine A.

Machine A = Machine B
FC + VC = FC + VC
$3,000 + $5 Q = $8,000 + $2Q
$3Q = $5,000
Q = 1667
Part 2: Comparison
Cont.
• Knowing the point of indifference we
will choose:

• Machine A when quantity demanded

is between 600 and 1667.

• Machine B when quantity demanded

exceeds 1667.
Part 2: Comparison
Graphically displayed
Dollars
21,000
18,000 Machine A
15,000
12,000
9,000 Machine B
6,000
3,000
0
500 1000 1500 2000 2500 3000
Quantity
Part 2: Comparison
Graphically displayed Cont.
Dollars
21,000
18,000 Machine A
15,000
12,000
9,000 Machine B
6,000
3,000 Point of indifference
0
500 1000 1500 2000 2500 3000
Quantity
Exercise 1:

• Company ABC sell widgets for $30 a

unit.

• Their fixed cost is$100,000

• Their variable cost is $10 per unit.

• What is the break-even point using

the basic algebraic approach?
Exercise 1:
Answer
Revenues – Variable cost - Fixed cost = OI

(USP x Q) – (UVC x Q) – FC = OI
$30Q - $10Q – $100,00 = $ 0.00
$20Q = $100,000
Q = 5,000
Exercise 2:

• Company DEF has a choice of two

machines to purchase. They both make
the same product which sells for $10.
• Machine A has FC of $5,000 and a per
unit cost of $5.
• Machine B has FC of $15,000 and a per
unit cost of $1.

• Under what conditions would you select

Machine A?
Exercise 2:
Answer
Step 1: Break-even analysis on both options.
Machine A:
v = $5,000
$10 - $5
= 1000 units
Machine B:
v = $15,000
$10 - $1
= 1667 units
Exercise 2:
Answer Cont.
Machine A = Machine B
FC + VC = FC + VC
$5,000 + $5 Q = $15,000 + $1Q
$4Q = $10,000
Q = 2500

• Machine A should be purchased if

expected demand is between 1000
and 2500 units per year.
Summary:

• Break-even analysis can be an

effective tool in determining the cost
effectiveness of a product.

• Required quantities to avoid loss.

• Use as a comparison tool for making

a decision.