3.

3 – Break Even Analysis

Key topics
● Contribution Margin
● Break Even
● Margin of Safety
● Target Profit
● How to graph BEPs

Breakeven chart
 Table of Contents
Break Even Point Example - Devil Sticks 3

Calculating Break Even Point 3

Example #1 - Devil Sticks 4

Advantages of B.E. 5

Limitations of B.E. 5

Contribution 5

EXAMPLE #2 - Jeans: 5

Margin of Safety 6

Practice Questions 7

Question #1 (Page 243) 7

Question #2 Katia Jewellery (Page 243) 8

Question #3 - Day Care (Page 244) 9

Question #4 - Road Trip!! 10

Question #5 New Product 11

Question #6 - RT’s Hot Dogs - 3.3.4 (Page 246) (Assume 30 day month) 12

Question #7 - BEP Quick Calculations - Table 13

Answers to Practice Questions 14

Answer #1 (Page 243) 14

Answer #2 Katia Jewellery (Page 243) 15

Answer #3 - Day Care (Page 244) 16

Answer #4 - Road Trip!! 18

Answer #5 New Product 19

Answer #6 - RT’s Hot Dogs - 3.3.4 (Page 246) (Assume 30 day month) 20

Answer #7 - BEP Quick Calculations - Table 21

Break Even Point Example - Devil Sticks
It was late August 1995. The Montreal Expos
were a great baseball team, the Toronto
Maple Leafs were consistently in the playoffs,
and Jeremy Bracken was about to enter
grade 8.

At the Tecumseh Corn Fest, he noticed a fad

called Devil Sticks. They were selling for
$25-$30 each... until they sold out. He really
wanted a pair so he asked his mom to take
him to Home Hardware to purchase the
resource inputs required to produce the
Devil Sticks.

Upon returning to school in September, he

observed that many classmates wanted Devil Sticks, but there was a shortage in supply because the
vendors were long gone. Jeremy identified this as an opportunity to make more Devil Sticks and sell
them to classmates during recess. Devil Sticks in action http://www.youtube.com/watch?v=Ka0ah44fIkA

Jeremy took custom orders and proceeded to make the sticks in his
garage. He decided to sell them for $20 each and his variable cost was
$7/unit. Although he didn't strike it rich, the venture was profitable and
Jeremy enjoyed the experience. As he grew older, his entrepreneurial
tendencies continued to show up through various other ventures.

Calculating Break Even Point

There are 3 ways to calculate the break-even point
1. Total Revenue = Total Cost
2. Fixed Cost / Contribution Margin
3. Interpretation from a graph

Let's say Jeremy wanted to set up a booth at a fall festival to sell his product. The festival would charge
him a fee of $100. He also spends $30 to make a poster and booth to attract customers. Since these
two costs are FIXED when his number of sales goes up, they are classified as FIXED COSTS.

As mentioned earlier, he makes the product at a VARIABLE COST of $7 and sells them for $20 each.
Therefore, he has a CONTRIBUTION MARGIN of $13. Every sale he makes does the following:

● Adds $20 to revenue

● Adds $7 to variable cost
● Pays off the fixed cost by $13 (before the BEP) OR adds $13 to the profit (after reaching BEP)
Example #1 - Devil Sticks
Calculate the BEP via the: TR=TC method

TR = TC

(P x Q) = (FC + VC)

(20Q) = (130 + 7Q)

20Q-7Q = 130 + 7Q-7Q

13Q= 130

13Q/13 = 130 /13

Q = 10

Calculate the BEP via the: Fixed Cost/Contribution Margin method

= 130 / (20-7)

= 130/13

= 10

Calculate the BEP by charting: Fixed Cost (FC), Variable Cost (VC), Total Cost (TC), Revenue.

*When doing this, it is important to find a suitable range of numbers. I personally like calculating a set of
graphing points first. Fill in the table below.

Units Sold (Q) Revenue Variable Cost Fixed Cost Total Cost Profit
0 0 0 130 130 -130
5 100 35 130 165 -65
10 200 70 130 200 0
11 220 77 130 207 13
15 300 105 130 235 65
20 400 140 130 270 130

Target profit

Q (tp) = (FC + Target $) / CM

= (130 + 65) /13

Advantages of B.E.
● provides a focus for the business
● provide a clear, visual demonstration of some vital financial information
● not complex, expensive or time consuming process
● shows the financial impacts of changes in costs and selling price
● predict whether further investment in the product is worthwhile

Limitations of B.E.
● Do not take into account possible changes in costs over the time period.
● Analysis is only as good as the quality of information.
● Do not allow for changes in market conditions in the time

Break even exists when a business makes neither a profit nor a loss. Therefore, in breakeven, total
revenue = total costs. → TR = TC

Contribution
The concept of contribution is crucial to understanding break even analysis. Recall that unit contribution
is the difference between a product’s price and its variable cost of production (from 3.2). A product that
makes a positive contribution will help towards paying the fixed costs of a business. After the break even
point, all additional sales represent profit. There are 3 broad ways in which profit can be improved.

● Increase price

● Decrease variable cost

● Increase quantity sold

Carrying out a break even analysis can inform managers of two things

● Whether it is financially worthwhile to produce a particular good or service, such as introducing a

new product

● The level of output that a business is likely to earn if things go according to plan.

EXAMPLE #2 - Jeans:
Jeans retailer has FC of $2500/month Price = $30 Variable cost = $10

We have 3 ways to calculate the break even point

1. Interpretation from chart
2. Using the TC=TR rule
3. Using the unit contribution rule: Break even = FC/unit contribution
= 2500/20
= 125
Draw interpretation from chart below
Units Sold Revenue Variable Cost Fixed Cost Total Cost Profit
($30/unit)
0 0 0 2500 2500 -2500
50 1500 500 2500 3000 -1500
100 3000 1000 2500 3500 -500
125 3750 1250 2500 3750 0
150 4500 1500 2500 4000 500
200 6000 2000 2500 4500 1500

Use the TC = TR rule and show calculations below

TR = TC

PxQ = FC + VC

30Q = 2500 + 10Q

30Q - 10Q = 2500

20Q = 2500

Q = 125

Use unit contribution calculation below

BEP = FC/CM

= 2500/(20)

= 125

Margin of Safety
The margin of safety refers to the difference between a firm’s current sales quantity and the quantity
needed to break even. A positive safety margin means the firm is making a profit. The larger the safety
margin, the safer a company is in a time of changing external economic factors.

Safety margin = Level of demand – break even quantity

Practice Questions
Question #1 (Page 243)
Tread-it is a manufacturer of hiking shoes. Play-it produces wooden toys for children. Cost and revenue
data for both are shown below.

Tread-it Play-it
Break-even quantity 250 500
Output 500 i
Margin of safety (units) ii 300
Margin of safety (%) 100 iii

a. Calculate the missing figures for i, ii, iii above

b. Comment on which firm has the better margin of safety
Question #2 Katia Jewellery (Page 243)
Katia Jewellery Ltd. sells handmade jewellery at an average price of $260 with variable costs averaging
$120 per unit. The fixed costs are $3500. In order to plot the break even chart, it is necessary to first
calculate

● The BEQ – Using the unit contribution method, the BEQ is calculated as

BEP = FC / CM

● The value of costs and revenues at the BEQ – Since the value of TC and TR are the same at the
BEQ, it does not matter is worked out. For example if

● TC = TR

=?

From page 244, we can see it illustrated on the graph.

Katia Jewellery Ltd. sells handmade jewellery at an average price of $260 with variable costs averaging
$120 per unit. The fixed costs are $3500. In order to plot the break even chart, it is necessary to first
calculate

● The BEQ – Using the unit contribution method, the BEQ is calculated as

BEP = FC / CM

= ?/(?-?)

= ? units

● The value of costs and revenues at the BEQ – Since the value of TC and TR are the same at the
BEQ, it does not matter is worked out. For example if

● TC = ?+ (? x ?) = $?.

● TR, the figure would be $260 x ___ = $?.

Question #3 - Day Care (Page 244)
Lisa Chan runs a children’s day care centre. The main clients are working parents who pay a fixed $20
per child for the whole day. Children at the centre learn through play and are engaged in activities such as
art, music, dance and physical education. The business is open for an average of 22 days each month.
The firm’s expected cost and revenue for the next year are as follows

ITEM DATA Categorize Amount per month

(FC, VC, Rev)
Capacity 25 children a day 20 kids per day is
avg
Demand 80% of capacity
Price $20/day Revenue
Materials $4/child/day VC
Rent $600/month FC
Salaries $1000/month FC
Administration $100/month FC
Power $140/month FC
Contribution 20 - 4 = 16
SM

a. Calculate the total fixed cost

FC = __1840_____ per month
b. Calculate the contribution margin
CM = P - VC
= 16
c. Calculate the monthly revenue
Revenue =PxQ
= 20 x 440
= 8800
d. Calculate the break even quantity per month
BEP = FC/CM
= 1840 / 16
= 115
e. Calculate the monthly profit
Profit = TR - TC
= 8800 - (FC + TVC)
= 8800 - (1840 + (4 x 440))
= 8800 - (1840 + 1760)
= 5200
f. Calculate the safety margin
 SM = 440 - 115
= 325
Profit = TR - TC
Profit = Safety Margin x Contribution Margin

g. Construct a fully labelled break-even chart for TMR Day Care Centre
h. Identify both the break-even point and break even output on your chart
Examine the strengths and weaknesses of using break even analysis for a business such as this
one.
Question #4 - Road Trip!!
Jeremy is running a bus trip to Toronto with his friends for 3 days and 2 nights. They are going
to a couple baseball games and want to do some sight seeing. He wants to charge everyone a
fixed amount regardless of the number of people who sign up.

Because he is booking in large numbers, he is able to negotiate a good price with the hotel and
also can get a group discount on tickets. He is responsible to pay for the driver's hotel room and
opts for a cheaper option away from downtown. He must also tip the driver.

#1. Classify the following trip expenses as fixed or variable.

Expense Cost Fixed or Variable Cost? How much in total?
Bus 1400/day Fixed = 4200
Hotel Rooms 120/night Variable TVC = 240 VC = 60
Hotel Room for driver 70/night Fixed = 140
Tickets 25/person Variable = 25
Food and drinks for the bus 200 Fixed 200
Prizes $ 100 Fixed 100
Tip - 150 Fixed 150
#2 - What is the fixed cost for the trip?

#3 - What is the marginal cost per attendee?

The bus can carry up to 55 passengers. He wants to charge $220/person for the trip and have
4 people per hotel room.

#5 - Calculate the following

Number of Total Revenue Fixed Variable Total Profit/Loss

people =PxQ Expenses Expenses Expenses
20

28

36

44

52

# 6 - Do you think he is charging an appropriate price? Why/why not? What price would you
recommend?

#7 - What would you do if an odd number of people expressed interest in going?

Question #5 New Product
An e-commerce manufacturer wants to invest $85000 in making the factory mold for a new
product. Each unit will cost $2.10 to make, plus an additional $0.15 in packaging. This good will
sell for $30 each but the manufacturer will incur the $5/unit shipping cost.

1. What is the fixed cost?

2. What is the variable cost?

3. What is the contribution margin?

4. What is the break even point?

5. How many units must be sold to earn $75000 in profit?

6. Chart the break-even point.

Question #6 - RT’s Hot Dogs - 3.3.4 (Page 246) (Assume 30 day month)

Category Monthly
Capacity 200/day
Sales Volume 110/day
Unit Price $2.50 Revenue
Ingredients/Materials $0.80 VC
Rent $200/month FC
Salary $500/month FC
Other overhead $320/month FC

1. Calculate BEP
= FC / CM
= $1020 / 1.70
= 600

2. Calculate monthly profit

= TR - TC
= 8250 - (1020 + 2640)
= 4590

3. If sales volume increases to 70% of capacity and rent goes up by 50%, what is the new
BEP and profit level?
Question #7 - BEP Quick Calculations - Table

Safety
Fixed Variable BEP Cont Revenue Margin
Cost ($) Cost ($) Price ($) (Units) Marg $ at BEP $ Units Sold Units

#1 1000 5 10 A B C 320 D

#2 E F 75 600 50 45000 G 20

#3 H 35 40 13,000 5 520,000 20,000 7000

#4 500 250 1250 -10

#5 52,000 9 13 6200

#6 8 15 100 1500 40
Answers to Practice Questions
Answer #1 (Page 243)
Tread-it is a manufacturer of hiking shoes. Play-it produces wooden toys for children. Cost and revenue
data for both are shown below.

Tread-it Play-it
Break-even quantity 250 500
Output 500 i (800)
Margin of safety (units) ii (250) 300
Margin of safety (%) 100 iii (60%)

c. Calculate the missing figures for i, ii, iii above

d. Comment on which firm has the better margin of safety
Answer #2 Katia Jewellery (Page 243)
Katia Jewellery Ltd. sells handmade jewellery at an average price of $260 with variable costs averaging
$120 per unit. The fixed costs are $3500. In order to plot the break even chart, it is necessary to first
calculate

● The BEQ – Using the unit contribution method, the BEQ is calculated as

BEP = FC / CM

= 3500/140

= 25

● The value of costs and revenues at the BEQ – Since the value of TC and TR are the same at the
BEQ, it does not matter is worked out. For example if

● TC = TR

=?

From page 244, we can see it illustrated on the graph.

Katia Jewellery Ltd. sells handmade jewellery at an average price of $260 with variable costs averaging
$120 per unit. The fixed costs are $3500. In order to plot the break even chart, it is necessary to first
calculate

● The BEQ – Using the unit contribution method, the BEQ is calculated as

BEP = FC / CM

= ?/(?-?)

= ? units

● The value of costs and revenues at the BEQ – Since the value of TC and TR are the same at the
BEQ, it does not matter is worked out. For example if

● TC = ?+ (? x ?) = $?.

● TR, the figure would be $260 x ___ = $?.

Answer #3 - Day Care (Page 244)
Lisa Chan runs a children’s day care centre. The main clients are working parents who pay a fixed $20
per child for the whole day. Children at the centre learn through play and are engaged in activities such as
art, music, dance and physical education. The business is open for an average of 22 days each month.
The firm’s expected cost and revenue for the next year are as follows

ITEM DATA Categorize Amount per month

(FC, VC, Rev)
Capacity 25 children a day -
Demand 80% of capacity - 440 kids/month

Price $20/day Revenue (20 x 440) = 8800

Materials $4/child Variable ( 4 x 440) = 1760
Rent $600/month Fixed 600
Salaries $1000/month Fixed 1000
Administration $100/month Fixed 100
Power $140/month Fixed 140

a. Calculate the total fixed cost

FC = (600 + 1000 + 100 + 140) = 1840
b. Calculate the contribution margin
CM = P - VC
= 20 - 4
= 16
c. Calculate the monthly revenue
Revenue = P x Q
= 20 x 440 = 8800
d. Calculate the break even quantity per month
BEP = FC/CM
= 1840/16 = 115
e. Calculate the monthly profit
Profit = TR - TC
= (P x Q) - (VC + FC)
= (8800) - ((4 x 440) + 1840)
= 8800 - (1760+1840)
= 5200
f. Calculate the safety margin
SM = 440 - 115
 = 325

g. Construct a fully labelled break-even chart for Lisa Chan’s Day Care
Centre
h. Identify both the break-even point and break even output on your chart
Examine the strengths and weaknesses of using break even analysis for a business
such as this one.
Answer #4 - Road Trip!!
Jeremy is running a bus trip to Toronto with his friends for 3 days and 2 nights. They are going
to a couple baseball games and want to do some sight seeing. He wants to charge everyone a
fixed amount regardless of the number of people who sign up.

Because he is booking in large numbers, he is able to negotiate a good price with the hotel and
also can get a group discount on tickets. He is responsible to pay for the driver's hotel room and
opts for a cheaper option away from downtown. He must also tip the driver.

#1. Classify the following trip expenses as fixed or variable.

Expense Cost Fixed or Variable Cost? How much in total?

Bus 1400/day Fixed - 1400 x 3 = 4200
Hotel Rooms 120/night Variable - 60
Hotel Room for driver 70/night Fixed - 140
Tickets 25/person Variable - 25
Food and drinks for the bus 200 Fixed - 200
Prizes $ 100 Fixed - 100
Tip - 150 Fixed - 150

#2 - What is the fixed cost for the trip?

Fixed Cost = 4200 + 140 + 200 + 100 + 150
= 4790
#3 - What is the variable cost per attendee? ( It acknowledges the additional cost incurred from each additional
attendee)
Variable Cost = 60 + 25
= 85/person
The bus can carry up to 55 passengers. He wants to charge $220/person for the trip and have
4 people per hotel room.
#5 - Calculate the following

Number of Total Revenue Fixed Variable Total Profit/Loss

people =PxQ Expenses Expenses Expenses
20 4790 1700 6490 -2090
4400
28 4790 2380 7170 -1010
6160
36 4790 3060 7850 70
7920
44 4790 3740 8530 1150
9680
52 4790 4420 9210
11,440
# 6 - Do you think he is charging an appropriate price? Why/why not? What price would you recommend?
#7 - What would you do if an odd number of people expressed interest in going?

Answer #5 New Product

An e-commerce manufacturer wants to invest $85000 in making the factory mold for a new
product. Each unit will cost $2.10 to make, plus an additional $0.15 in packaging. This good will
sell for $30 each but the manufacturer will incur the $5/unit shipping cost.

1. What is the fixed cost? $85000

2. What is the variable cost? $7.25

3. What is the contribution margin? (30 - 7.25) = 22.75

4. What is the break even point? BEP = FC / 22.75 = 3736 Units

5. How many units must be sold to earn $75000 in profit? Target Q = (FC + TP)/CM

= (85000+75000) / 22.75

= 7033 Units

6. Chart the break-even point.

Answer #6 - RT’s Hot Dogs - 3.3.4 (Page 246) (Assume 30 day month)

Category Monthly
Capacity 200/day Demand 6000
Sales Volume 110/day Demand 3300
Unit Price $2.50 Revenue
Ingredients/Materials $0.80 VC 2640
Rent $200/month FC 200
Salary $500/month FC 500
Other overhead $320/month FC 320

4. Calculate BEP
= FC / CM
= 1020 / 1.70
= 600

5. Calculate monthly profit

= TR - TC
= (P x Q) - (FC + VC)
= (2.50 x 3300) - (1020 + 2640)
= 8250 - 3660
= 4590

6. If sales volume increases to 70% of capacity and rent goes up by 50%, what is the new
BEP and profit level?
BEP = FC / CM
= 1120 / 1.70
= 659
profit = TR - TC
= (P x Q) - (FC + VC)
= (2.50 x 4200) - (1 120 +3360)
= 10,500 - 4480
= 6020
Answer #7 - BEP Quick Calculations - Table
Safety
Fixed Variable BEP Cont Revenue Margin
Cost ($) Cost ($) Price ($) (Units) Marg $ at BEP $ Units Sold Units

#1 1000 5 10 200 5 2000 320 120

#2 30,000 25 75 600 50 45000 620 20

#3 65,000 35 40 13000 5 520000 20000 7000

#4 500 3 5 250 2 1250 240 -10

#5 52000 9 22 4000 13 88000 6200 2200

#6 700 8 15 100 7 1500 140 40