BREAK EVEN ANALYSIS

AND
MANAGEMENT SCIENCE
MODELING TECHNIQUES
PRINCESS CATHERINE M. SANTIAGO, MBM
 LEARNING OUTCOME
At the end of this unit, the students will:

• correlate break-even analysis and management

science techniques to their daily lives by knowing the
overall ability of their family to generate an income
and properly manage them to cover their expenses
during this pandemic.
• apply the importance of computation of total cost,
total revenue, total profit and break-even point to
business decision making.
 CONTENTS

1 Definition of Break-even Analysis 2 Components of Break-evenAnalysis

Computing the Break-even

3 point and its Graphical 4 Sensitivity Analysis
Solution

5 Management Science
Modelling Techniques
 BREAK-EVEN
01 ANALYSIS
 BREAK-EVEN ANALYSIS

a modeling technique to determine the number of units to

sell or produce that will result in zero profit. This is also
called profit analysis.
 BREAK-EVEN ANALYSIS
PURPOSE:

q to determine the number of units of a product to sell or produce that

will equate total revenue with total cost.
q It helps to determine remaining/unused capacity of the company
once the breakeven is reached. This will help to show the maximum
profit on a particular product/service that can be generated.
q It helps to determine the impact on profit on changing to automation
from manual (a fixed cost replaces a variable cost).
q It helps to determine the change in profits if the price of a product is
altered.
q It helps to determine the amount of losses that could be sustained if
there is a sales downturn.
 COMPONENTS OF
02 BREAK-EVEN
ANALYSIS
 COMPONENTS OF BREAK-EVEN ANALYSIS

q Volume - is the level of sales or production by a

company.

q Cost - the monetary value of expenditures for supplies,

services, labor, products, equipment and other items
purchased for use by a business

q Profit - the difference between total revenue (volume

multiplied by price) and total cost.
 BREAK-EVEN ANALYSIS
COST

q Fixed costs are generally independent of the volume of units

produced and sold and remain constant.
q Variable costs are determined on a per-unit basis. Thus, total
variable costs depend on the number of units produced.

Total variable costs are a function of the volume and the

variable cost per unit. This relationship can be expressed
mathematically as

total variable cost = vcv

where cv = variable cost per unit and v = volume (number of units)
sold.

q Total cost (TC) equals the fixed cost plus the variable cost per unit
multiplied by volume (v)
 BREAK-EVEN ANALYSIS
total cost = total fixed cost + total variable cost

or

TC = cf + vcv
where cf = fixed cost

Example:

Penshoppe, incurs the following monthly costs to produce denim

jeans:

fixed cost = cf = P500,000

variable cost = cv = P400/pair
 BREAK-EVEN ANALYSIS

If we arbitrarily let the monthly sales volume, v, equal 400 pairs of

denim jeans, the total cost is:

TC = cf + vcv
= 500,000 + (400)(400)
= 500,000 + 160,000
TC = P660,000
 BREAK-EVEN ANALYSIS

The third component in our break-even model is profit. Profit is the

difference between total revenue and total cost. Total revenue is the
volume multiplied by the price per unit.

total revenue = vp
where p = price per unit

For our clothing company example, if denim jeans sell for P1,150 per
pair and we sell 400 pairs per month, then the total monthly revenue
is:
total revenue = vp
= (400)(1,150)
= P460,000
 BREAK-EVEN ANALYSIS

Now that we have developed relationships for total revenue and total
cost, profit (Z) can be computed as follows:

total profit = total revenue - total cost

Z = vp - (cf + vcv)
Z = vp - cf - vcv
 COMPUTING
BREAK-EVEN POINT
03 and its GRAPHICAL
SOLUTION
 COMPUTING BREAK-EVEN POINT
For our clothing company example, we have determined total
revenue and total cost to be P460,000 and P660,000, respectively.
With these values, there is no profit but, instead, a loss of P200,000:

total profit = total revenue - total cost

= P460,000 - P660,000
= - P200,000

We can verify this result by using our total profit formula:

Z = vp - cf - vcv
And the values are:
v = 400
p = 1,150
cf = 500,000
cv = 400
Z = (400)(1,150) - 500,000 - (400)(400)
= P460,000 - 500,000 - 160,000
= - P200,000
 COMPUTING BREAK-EVEN POINT

Obviously, the clothing company does not want to operate with a

monthly loss of P200,000 because doing so might eventually result in
bankruptcy. If we assume that price is static because of market
conditions and that fixed costs and the variable cost per unit are not
subject to change, then the only part of our model that can be varied
is volume. Using the modeling terms we developed earlier in this
chapter, price, fixed costs, and variable costs are parameters,
whereas the volume, v, is a decision variable. In break-even analysis
we want to compute the value of v that will result in zero profit.
 COMPUTING THE BREAK-EVEN POINT
BREAK-EVEN POINT
the point where total revenue equals
total cost and at this point profit is zero.

The break-even point gives a manager

a point of reference in determining how
many units will be needed to ensure a
profit.
 COMPUTING THE BREAK-EVEN POINT
BREAK-EVEN POINT
the point where total revenue equals
total cost and at this point profit is zero.

The break-even point gives a manager

a point of reference in determining how
many units will be needed to ensure a
profit.
 COMPUTING THE BREAK-EVEN POINT
At the break-even point, where total revenue equals
total cost, the profit, Z, equals zero. Thus, if we let
profit, Z, equal zero in our total profit equation and
solve for v, we can determine the break-even volume:

Z = vp - cf - vcv
0 = v(1,150) - 500,000 - v(400)
0 = 1,150v - 500,000 - 400v
-1,150v + 400v = -500,000
-750v = -500,000
v = -500.000/-750
v = 666.67 pairs of jeans
 COMPUTING THE BREAK-EVEN POINT

In other words, if the company produces and sells

666.7 pairs of jeans, the profit (and loss) will be zero
and the company will break even. This gives the
company a point of reference from which to determine
how many pairs of jeans it needs to produce and sell
in order to gain a profit (subject to any capacity
limitations). For example, a sales volume of 800 pairs
of denim jeans will result in the following monthly
profit:

Z = vp - cf - vcv
= (800)(1150) - 500,000 - (800)(400)
= 920,000 - 500,000 - 320,000
= 100,000
 COMPUTING THE BREAK-EVEN POINT

In general, the break-even volume can be determined

using the following formula:

Z = vp - cf - vcv
0 = v(p- cv) -cf
v(p- cv) = cf
v = cf / p- cv
For our example:

v = 500,000 / 1150 - 400

v = 500,000 / 750
v = 666.67 pairs of jeans
 GRAPHICAL SOLUTION

It is possible to represent many of the management

science models in this text graphically and use
these graphical models to solve problems.
Graphical models also have the advantage of
providing a “picture” of the model that can
sometimes help us understand the modeling
process better than mathematics alone can.
 GRAPHICAL SOLUTION
TOTAL
VOLUME PRICE VARIABLE COST TOTAL REVENUE TOTAL COST FIXED COST VARIABLE
COST
v p vc vp cf+vcv cf vcv

100 1,150 400 115,000.00 540,000.00 500,000.00 40,000

200 1,150 400 230,000.00 580,000.00 500,000.00 80,000

300 1,150 400 345,000.00 620,000.00 500,000.00 120,000

400 1,150 400 460,000.00 660,000.00 500,000.00 160,000

500 1,150 400 575,000.00 700,000.00 500,000.00 200,000

600 1,150 400 690,000.00 740,000.00 500,000.00 240,000

700 1,150 400 805,000.00 780,000.00 500,000.00 280,000

800 1,150 400 920,000.00 820,000.00 500,000.00 320,000

900 1,150 400 1,035,000.00 860,000.00 500,000.00 360,000

GRAPHICAL SOLUTION
 GRAPHICAL SOLUTION
• In the graph, the fixed cost has a constant value of 500,000, regardless
of the volume.

• The total cost line, TC, represents the sum of variable cost and fixed
cost. The total cost line increases because variable cost increases as
the volume increases.

• The total revenue line also increases as volume increases, but at a

faster rate than total cost.

• The point where these two lines intersect indicates that total revenue
equals total cost. (break-even point)

• The volume, v, that corresponds to this point is the break-even volume.

The break-even volume is 666.7 pairs of denim jeans
 INTERPRETATION OF BREAK-EVEN
ANALYSIS
• As illustrated in the graph above, the point at which total fixed and variable
costs are equal to total revenues is known as the break even point. At the
break even point, a business does not make a profit or loss. Therefore, the
break even point is often referred to as the “no-profit” or “no-loss point.”

• The break even analysis is important to business owners and managers in

determining how many units (or revenues) are needed to cover fixed and
variable expenses of the business.
 INTERPRETATION OF BREAK-EVEN
ANALYSIS
Therefore, the concept of break even point is as follows:

• Profit when Revenue > Total Variable cost + Total Fixed cost

• Break-even point when Revenue = Total Variable cost + Total Fixed cost

• Loss when Revenue < Total Variable cost + Total Fixed cost
 BREAK-EVEN ANALYSIS
When is Break-even analysis used?

• Starting a new business: To start a new business, a break-even analysis is a

must. Not only it helps in deciding whether the idea of starting a new
business is viable, but it will force the startup to be realistic about the costs,
as well as provide a basis for the pricing strategy.

• Creating a new product: In the case of an existing business, the company

should still peform a break-even analysis before launching a new product—
particularly if such a product is going to add a significant expenditure.

• Changing the business model: If the company is about to the change the
business model, like, switching from wholesale business to retail business,
then a break-even analysis must be performed. The costs could change
considerably and breakeven analysis will help in setting the selling price.
04 SENSITIVITY ANALYSIS
 SENSITIVITY ANALYSIS
We have now developed a general relationship for determining the break-even
vo l u m e, w h i ch w as t h e o b j ect i ve o f o u r m o d el i n g p r o c e s s . T h i s r e l a t i o n s h i p
enables us to see how the level of profit (and loss) is directly affected by
changes in volume. However, when we developed this model, we assumed that
our parameters, fixed and variable costs and price, were co n st an t . I n r eal i t y
such parameters are frequently uncertain and can rarely be assumed to be
constant, and changes in any of the parameters can affect the model solution.
The study of changes on a management science model is called sensitivity
analysis—that is, seeing how sensitive the model is to changes.
 SENSITIVITY ANALYSIS
Break-even analysis assumes that per unit selling price and variable cost do
not change, which is not always the case. Break-even models will change on
the following scenarios:

• change in price

• change in variable cost

• change in fixed cost

Business in order to sell more goods and services often have to reduce prices.
Sometimes prices are not in control of the business, since they depend on
market conditions and other factors such as government regulation.
 SENSITIVITY ANALYSIS
Va r i a b l e c o s t s a l s o c h a n g e a s m a t e r i a l , l a b o r a n d o t h e r i n d i r e c t v a r i a b l e
expenses could increase or decrease as quantity changes. For Example, Labor
rates will increase due to overtime if more units are produced. Other variable
cost could also vary with number of units. The break-even analysis also
assumes that all units produced are also sold, which is not always the case.
This tool fails to take into account the demand-side situation, since not all
units produced are sold at the assumed price.
 MANAGEMENT
05 SCIENCE MODELING
TECHNIQUES
 MANAGEMENT SCIENCE MODELING
TECHNIQUES

Among the Management Science process, two of the steps use the
M an ag emen t S ci en ce Tech n i q u es. T h ese a r e t h e m o d e l c o n s t r u c t i o n a n d
solution. It is difficult to show how an unstructured real-world problem is
identified and defined because the problem must be written out. However,
once a problem statement has been given, we can show how a model is
constructed and a solution is derived.
 MANAGEMENT SCIENCE MODELING
TECHNIQUES
The management science modeling process helps businesses to improve their
operations through the use of scientific methods and the development of specialized
t ech n i q u es. I t i s t h e p ro cess o f re search i n g f o r an o p t i m a l s o l u t i o n t o t h e e x i s t i n g
problem. Management science modeling process provides systematic, analytical and
general approaches to the problem solving for decision-making, regardless of the
nature of the system, product, or service. Management science modeling process is
the application of scientific methods to complex organizational problems. Models are
aimed at assisting the decision-maker in decision-making process. Management
science modeling process is one of the innovative decision making tool of the
twentieth century.
MANAGEMENT SCIENCE MODELING
TECHNIQUES
 CLASSIFICATION OF MANAGEMENT SCIENCE
TECHNIQUES
L i n e a r M a t h e m a t i c a l P r o g r a m m i n g Te c h n i q u e s - T h e t e r m p r o g r a m m i n g u s e d
to identify this technique does not refer to computer programming but rath er
to a predetermined set of mathematical steps used to solve a problem. This
particular class of techniques holds a predominant position in this subject
because it includes some of the more frequently used and popular techniques
in management science. In general, linear programming models help managers
determine solutions (i.e., make decisions) for problems that will achieve some
objective in which there are restrictions, such as limited resources or a recipe
or perhaps production guidelines. Linear programming is also use to solve
t ran sp o rt at i o n , t ran ssh i p men t , an d assi g n i n g p ro b l ems. L i n e a r p r o g r a m m i n g
i s w i d el y u sed i n p ro d u ct i o n p l a n n i n g a n d s c h e d u l i n g . I t i s v e r y w e l l u s e d i n
airline industry for aircraft and crew scheduling.
 CLASSIFICATION OF MANAGEMENT SCIENCE
TECHNIQUES
P r o b a b i l i s t i c Te c h n i q u e s - T h e s e t e c h n i q u e s a r e d i s t i n g u i s h e d f r o m m a t h e m a t i c a l
programming techniques in that the results are probabilistic. It is based on
application of statistics for probability of uncontrollable events as well as risk
assessment of decision. Mathematical programming techniques assume that all
p aramet ers i n t h e mo d el s are kn o w n w i t h cert ai n t y. T h ere f o r e , t h e s o l u t i o n r e s u l t s
a r e a s s u m e d t o b e k n o w n w i t h c e r t a i n t y, w i t h n o p r o b a b i l i t y t h a t o t h e r s o l u t i o n s
might exist. A technique that assumes certainty in its solution is referred to as
d e t e r m i n i s t i c . T h e r e s u l t s f r o m a p r o b a b i l i s t i c t e c h n i q u e d o c o n t a i n u n c e r t a i n t y,
with some possibility that alternative solutions might exist. Probability assessment
tries to fill gap between what is know and what need to be know for an optimal
solution. Therefore, probabilistic models are used to prevent events happening due
to adverse uncertainty.
 CLASSIFICATION OF MANAGEMENT SCIENCE
TECHNIQUES
N e t w o r k Te c h n i q u e s - N e t w o r k s c o n s i s t o f m o d e l s t h a t a r e r e p r e s e n t e d a s
diagrams rather than as strictly mathematical relationships. As such, these models
offer a pictorial repre_x0002_sentation of the system under analysis. These models
represent either probabilistic or deterministic systems. This model is used to solve
physical problems such as transportation or flow of commodities. This technique
uses most cost effective way to transport the goods, to determine
maximum/minimum possible flow from source to destination and to find shortest
critical path in large projects.
 CLASSIFICATION OF MANAGEMENT SCIENCE
TECHNIQUES
O t h e r Te c h n i q u e s - S o m e t e c h n i q u e s a r e n o t e a s i l y c a t e g o r i z e d ; t h e y m a y o v e r l a p s e v e r a l
categories, or they may be unique.

• The analytical hierarchy process (AHP) is a technique that is not easily classified. It is a
mathematical technique for helping the decision maker choose between several alternative
decisions, given m or e than one objec t i v e ; h o w e v e r, i t i s n o t a f o r m o f l i n e a r p r o g r a m m i n g , a s
is goal programming on multicriteria decision making.

• The structure of the mathematical models for nonlinear programming problems is similar to
t h e l i n e a r p r o g r a m m i n g p r o b l e m s . H o w e v e r, t h e m a t h e m a t i c a l e q u a t i o n s a n d f u n c t i o n s i n
n o n l i n e a r p r o g r a m m i n g c a n b e n o n l i n e a r i n s t e a d o f l i n e a r, t h u s r e q u i r i n g t h e u s e o f c a l c u l u s
to solve them.

• Simulation is probably the single most unique technique. It has the capability to solve
probabilistic and deterministic problems and is often the technique of last resort when no
other management science technique will work.
 SUMMARY
Small businesses are started and made successful by entrepreneurs who share
unique traits. However, as business complexity grows, the need to switch to more
formal planning and decision making based on a systematic analysis of multifaceted
business information also grows. As such, Management Science Modeling
Techniques are perfectly suited for helping such analyses with associated payoffs
that use small firms' scarce technical and managerial resources effectively and
efficiently. Break-even analysis on the other hand, is widely used to determine the
number of units the business needs to sell in order to avoid losses. This calculation
requires the business to determine selling price, variable costs and fixed costs. Once
these numbers are determined, it is fairly easy to calculate break-even point in units
or sales value.
 EVALUATION #1
Budgeting During A Pandemic (30)

1. Interview your parents and ask them how much is their income per month.

2. Indicate all your family expenses for one month.

3. Deduct your parents’ income to your family expenses.

4. What was the result? if there was a shortage, indicate the reason. If there
was a surplus/savings, provide your ways/methods of saving your money. if
it was break-even, what will be your improvements in your finances?

5. Is pandemic a great factor in your financial management?

6. What have you learned form this activity?

EVALUATION

Submissions will be graded based on the rubric for assessment of learning exercise provided below:

CRITERIA WEIGHT EXEMPLARY (4) ACCOMPLISHED (3) DEVELOPING (2) BEGINNING

(1)
Coverage 25% All required Most of the Some of the Most of the
information are required required required
covered, information are information are information are
informative, covered and well covered but missing and
and well-written written uninformative poorly written
Organization 10% All required Proper formatting Some formatting Multiple
information are with labelled errors or missing formatting errors
covered, sections sections or missing
informative, sections
and well-written
Grammar, usage, 25% No errors Only one or two Some formatting Numerous errors
mechanics, errors errors or missing distract from
spelling sections understanding
Quality of 40% Interesting, well- Only one or two Details somewhat Unable to find
information researched, errors sketchy, do not specific details
informative, support the topic
supporting details
specific to subject
 EVALUATION #2
Mon to Fri Laundry

When Phylbert Roque purchased the Mon to Fri Laundry, she thought that
because it was in a good location near several high-income neighborhoods, she
w o u l d a u t o m a t i c a l l y g e n e r a t e g o o d b u s i n e s s i f s h e i m p r o v e d t h e l a u n d r y ’s
physical appearance. Thus, she initially invested a lot of her cash reserves in
r e m o d e l i n g t h e e x t e r i o r a n d i n t e r i o r o f t h e l a u n d r y. H o w e v e r, s h e j u s t a b o u t
broke even in the year following her acquisition of the laundry, which she didn’t
feel was a sufficient return, given how hard she had worked. Phylbert didn’t
realize that the dry-cleaning business is very competitive and that success is
based more on price and quality service, including quickness of service, than on
the laundry’s appearance.
 EVALUATION #2
C u r r e n t l y, h e r l a u n d r y b u s i n e s s c a n o n l y c l e a n 1 5 c l o t h e s p e r h o u r ( o r
120 items per day). In order to improve her service, Phylbert is considering
purchasing new dry-cleaning equipment, including a pressing machine that
could substantially increase the speed at which she can dry-clean clothes and
improve their appearance. The new machinery costs P810,000 installed and can
cl ean 40 cl o t h es i t ems p er h o u r ( o r 320 i t ems p er d ay ) . T h e n e w m a c h i n e r y w i l l
give an additional fixed cost of P106,250. Phylbert estimates her variable costs
to be P12.50 per item dry-cleaned, which will not change if she purchases the
new equipment. Her current fixed costs are P85,000 per month. She charges
customers P55 per clothing item.
 EVALUATION #2
A. What is Phylbert’s current monthly (30days) volume? (5)
B. If Phylbert purchases the new equipment, how many items
will she have to dry-clean each month to break even? (10)
C. Phylbert estimates that with the n e w e q u i p m e n t , s h e c a n
increase her current volume to additional 6,000 items per
month. What monthly profit would she realize with that level of
business? What would be her total profit in 3 years? (10)
 EVALUATION #2
D. Phylbert believes that if she doesn’t buy the new equipment
but lowers her price to P49.50 per item, she will increase her
bus i n e s s v o l u m e . I f s h e l o w e r s h e r p r i c e , w h a t w i l l h e r n e w
break-even volume be? If her price reduction results in a
monthly volume of 3,800 items, what will her monthly profit be?
(20)
E. Phylbert estimates that if she purchases the new equipment
and lowers her price to P49.50 per item, her volume of 9,600
will have an increase of 4,700 units per month. What will her
total profit be? (10)
 EVALUATION #2
F. A s P h y l b e r t ’s M a n a g e r i a l S c i e n t i s t , w h a t w i l l b e t h e d e c i s i o n o f P h y l b e r t t o
gain the highest profit? How will you explain the relationship of equipment,
volume and price to her profit. (15)

F.1 Do not buy the new equipment

F.2 Do not buy the eqipment, but lower the price to P49.50

F. 3 B u y t h e e q u i p m e n t , w i t h e s t i m a t e d v o l u m e o f 9 6 0 0 i t e m s p e r m o n t h
and with the same price

F. 4 B u y t h e e q u i p m e n t , w i t h e s t i m a t e d v o l u m e o f 9 6 0 0 i t e m s a n d a n
increase of 4700 per month, then lower the price to P49.50

F. 5 B u y t h e e q u i p m e n t , w i t h e s t i m a t e d v o l u m e o f 9 6 0 0 i t e m s p e r m o n t h
and increase the price to P60
 REFERENCES
Break-Even Analysis – Definition, Formula & Examples.(2021, March
18).ClearTax.https://cleartax.in/s/break-even-analysis

Break Even Analysis.(n.d).Corporate Finance

Institute.https://corporatefinanceinstitute.com/resources/knowledge/modeling/break-even-analysis/

Break-Even Analysis: What, Why, and How.(2019, September

19).Cleverism.https://www.cleverism.com/break-even-analysis

Management science modeling techniques.(2008, February 8).Business Management

Wordpress.https://businessmanagement.wordpress.com/2008/02/08/management-science-modeling-
techniques/

Taylor, B.W. (2013).Introduction to Management Science.Pearson

THANK YOU