# BreakBreak-Even Analysis

Srinivas Gumparthi

Defined:
BreakBreak-even analysis examines the cost tradeoffs associated with demand volume.

Overview:
BreakBreak-Even Analysis
    Benefits Defining Page Getting Started Break-even Analysis Break² Break-even point Break² Comparing variables  Algebraic Approach  Graphical Approach

Benefits and Uses:
 The evaluation to determine necessary levels of service or production to avoid loss.  Comparing different variables to determine best case scenario.

Defining Page:
 USP  UVC  FC  Q = Unit Selling Price = Unit Variable costs = Fixed Costs = Quantity of output units sold (and manufactured)

Defining Page:
Cont.
 OI  TR  TC  USP = Operating Income = Total Revenue = Total Cost = Unit Selling Price

Getting Started:
 Determination of which equation method to use: ² Basic equation ² Contribution margin equation ² Graphical display

BreakBreak-even analysis:
BreakBreak-even point
 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 breakbreak-even?  How much will he need to sell to make \$1000?

Algebraic approach:
Basic equation
Revenues ² Variable cost ² Fixed cost = OI

(USP x Q) ² (UVC x Q) ² FC = OI \$10Q - \$5Q ² \$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

Algebraic approach:
Contribution Margin equation
(USP ² 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

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

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

Scenario 1:
BreakBreak-even Analysis Simplified
 When total revenue is equal to total cost the process is at the break-even breakpoint. TC = TR

BreakBreak-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.

BreakBreak-even analysis:
Comparative analysis Part 1
 Determine break-even point for breakMachine A and Machine B.  Where: V = FC SP - VC

BreakBreak-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: ² 600 units are the minimum. ² 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 FC + VC \$3,000 + \$5 Q \$3Q Q = Machine B = FC + VC = \$8,000 + \$2Q = \$5,000 = 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 breakthe basic algebraic approach?

Exercise 1:
Revenues ² Variable cost - Fixed cost = OI

(USP x Q) ² (UVC x Q) ² FC \$30Q - \$10Q ² \$100,00 \$20Q Q

= = = =

OI \$ 0.00 \$100,000 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:
Step 1: Break-even analysis on both Breakoptions. Machine A: v = \$5,000 \$10 - \$5 = 1000 units Machine B: v = \$15,000 \$10 - \$1 = 1667 units

Exercise 2:
Machine A FC + VC \$5,000 + \$5 Q \$4Q Q = Machine B = FC + VC = \$15,000 + \$1Q = \$10,000 = 2500

 Machine A should be purchased if expected demand is between 1000 and 2500 units per year.

Summary:
 Break-even analysis can be an Breakeffective tool in determining the cost effectiveness of a product.  Required quantities to avoid loss.  Use as a comparison tool for making a decision.

Bibliography:
Russel, Roberta S., and Bernard W. Taylor III. Operations Management. Upper Saddle River, NJ: Pentice-Hall, Pentice2000. Horngren, Charles T., George Foster, and Srikant M. Datar. Cost Account. 10th ed. Upper Saddle River, NJ: PenticePentice-Hall, 2000.