Professional Documents
Culture Documents
Website - variable
Equipment - variable
Marketing - variable
Employees - fixed
Insurance – semi-variable
Rent – fixed
Lesson objectives
To explain the different types of costs through discussion and activity.
To calculate break-even point and demonstrate the technique of drawing a break-
even chart.
To apply break-even, revenue and cost calculations to a case study.
Classification of costs
The Break-even model involves looking at how revenues and costs behave at different levels
of output and then forecasting what happens to profit at different levels of output.
In the break-even model it is necessary to divide costs into their fixed and variable elements,
so it is important to first understand how different types of costs behave, so that we can
distinguish between them.
Fixed Costs
Fixed costs must be paid even if the business does not produce anything.
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So, it is more cost effective for businesses to use their premises intensively, as they pay the
same rent when producing high output as a low output.
600
500
400
£000
300
200
100
0 10 20 30 40 50
Units
Variable Costs
If output doubled then all of the above these costs would double. However, in reality
the costs do not necessarily increase proportionately to output, why is this?
600
500
400
£000
300
200
100
Examples include:
Vehicles Fixed = insurance
Variable = fuel
600
500
400
£000
300
200
100
0 10 20 30 40 50
Units
Pit Stop
Explain the difference between fixed and variable costs in less than 20 words.
Variable costs change based on the amount of output produced. Fixed costs remain the
same regardless of production output.
Now – revisit the list of costs you made for your mobile dog grooming business and
classify each cost into fixed, variable and semi-variable.
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The Break-even Model
A key area of business planning is being able to forecast
the point at which a profit is made on a decision.
Contribution
Break-even calculations use the idea of ‘contribution’. This is where the
difference between the selling price and the variable cost of producing a
product, goes towards ‘paying off’ the fixed costs, or overheads of producing
that product.
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The break-even point can be pin-pointed on an accurate diagram, but it can be
more accurately calculated with the following equation, using the idea of
contribution:
A worked example
Student Summer Ball
Projections of costs:
Projections of revenue
Tickets will be £30 each and it is estimated that 600 (output) will be sold.
costs = revenue
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Profit calculation
Margin of Safety
The margin of safety is the difference between the target level of output and
the break-even level of output. The margin of safety gives the business an
idea of how much room they have for sales to fall below the target level of
activity, before there is a danger of making a loss.
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To draw a break-even chart you will need to use your knowledge of the different types
of costs and how they are drawn on a graph. Remind yourself by drawing in the lines
that represent the terms and give business examples of each:
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Drawing the break-even chart – for the Summer Ball
This is a graphical representation of the relationship between costs and revenues and
output. The diagram is built up by graphing each monetary variable against output.
Fixed Costs
Fixed costs stay constant at £_________ as they do not vary with output, even if no tickets
are sold costs must be paid.
Total Costs
The fixed and variable costs are added together and plotted.
Revenue
The sales revenue is plotted first by calculating total sales revenue at the expected output –
in this case the number of sales of tickets.
Check that your chart shows the correct break-even point. If it does not, what could
the reasons be for this?
End task:
If 63 tickets were sold a month, how many months would it take to sell the break-even
quantity?