Break-Even Analysis Is Used To

Break-Even Analysishttp://www.bized.ac.
uk
• Break-Even Analysis is used to
– predict future profits/losses
– predict results eg produce Product A or Product
B
• Break-Even Point is when Sales Revenue
equals Total Costs
• at this point no profit or loss is incurred
• the firm merely covers its total costs
• Break-Even Point can be shown in graph
form or by use of formulae
Break-Even Analysishttp://www.bized.ac.uk
In order to calculate how profitable a product will be,
we must firstly look at the Costs involved -
There are two basic types of costs a company incurs.
• Variable Costs
• Fixed Costs
Variable costs are costs that change with changes in production

levels or sales. Examples include: Costs of materials used in the
production of the goods.
Fixed costs remain roughly the same regardless of sales/output

levels. Examples include: Rent, Insurance and Wages
Break-Even Analysis
http://www.bized.ac.uk
• TOTAL COSTS
– Total Costs is simply Fixed Costs and Variable Costs
added together.
TC = FC + VC
– As Total Costs include some of the Variable Costs then
Total Costs will also change with any changes in
output/sales.
– If output/sales rise then so will Total Costs.
– If output/sales fall then so will Total Costs.
Break-Even Analysis http://www.bized.ac.uk
The Break-even point occurs when Total Costs equals

Revenue (Sales Income)
Revenues (Sales Income) = Total Costs

At this point the business is not making a Profit nor
incurring a Loss – it is merely covering its Total Costs
Let us have a look at a simple example.
Bannerman Trading Company

opens a flower shop.
Fixed Costs:
• Rent: £400
• Helper (Wages): £200
Variable Costs:
• Flowers: £0.50 per bunch
Selling Price:
• Flowers: £2 per bunch
So we know that:
Total Fixed Costs = £600
Variable Cost per Unit = £0.50
Selling Price per Unit = £2.00
Break-Even Analysis SP = £2.00
VC = £0.50
FC = £600
• We must firstly calculate how much income from

each bunch of flowers can go towards covering the
Fixed Costs.
This is called the Unit Contribution.

Selling Price – Variable Costs = Unit Contribution
£2.00 - £0.50 = £1.50
• For every bunch of flowers sold £1.50 can go towards
covering Fixed Costs
SP = £2.00
VC = £0.50
Now to calculate how many units must Unit cont = £1.50
be sold to cover Total Costs (FC + VC)
FC = £600
This is called the Break Even Point

Break Even Point =
Fixed Costs  Unit Contribution
£600  £1.50 = 400 Units
Therefore 400 bunches of flowers must be sold to Break

Even – at this the point the business is not making a
Profit nor incurring a Loss – it is merely covering its
Total Costs
Lets try another example:

Selling Price per unit = £5
Variable Cost per unit = £2
Fixed Costs = £300
How many units must be sold in order to Break
Even?
First calculate the Unit Contribution VC = £2.00
SP – VC = Unit Contribution FC = £300
£5.00 - £2.00 = £3.00
Now calculate Break Even point by using the

formula –
£300  £3.00 = 100 units
Therefore 100 units must be sold in order to Break
Even
Lets try another example:

A firm has Fixed Costs of £1,200.
The Selling Price is £6 per unit and the
Variable Costs are £3 per unit.
How many units must be sold in order to Break

Even?
First calculate the Unit Contribution VC = £3.00
SP – VC = Unit Contribution FC = £1,200
£6.00 - £3.00 = £3.00
Now calculate Break Even point by using the

formula –
£1,200  £3.00 = 400 units
Therefore 400 units must be sold in order to Break
Even
Break Even can also be used to calculate Profit (or Loss)

at a given level of output
For example:
J Bannerman sells Golf Clubs. How much profit/loss is
made when 5000 golf clubs are sold?
Each Golf Club is sold for £20

Variable Costs per golf club are £10
Fixed Costs total £24,000
VC = £10.00
Firstly, calculate Unit Contribution
FC = £24,000
SP – VC = Unit Contribution
Sales = 5,000 units
£20.00 - £10.00 = £10.00
Now calculate Total Contribution when 5,000 golf
clubs are sold
Unit Contribution x no of units = Total Contribution
£10.00 x 5,000 = £50,000
Now calculate Net Profit at 5,000 units
Total Contribution – Fixed Costs = Net Profit
£50,000 - £24,000 = £26,000
Variable Costs =
So:
Flowers £1.49
SP = £2.50
Fixed
PaperCosts = £0.01
Lets try another example.
VC = £1.50
Rent
(£3/300) £1,050
Insurance
FC = £1,250£200
Caroline Wilson owns a florist Total FC
shop. Total VC £1,250£1.50
She buys each bunch of flowers for £1.49 and

special wrapping paper for £3 per roll. Each roll
of wrapping paper will wrap 300 bunches of
flowers. Rent of her premises is £1,050 per
month and she pays monthly insurance of £200.
Caroline sells each bunch of flowers for £2.50.
What do we know?
SP = £2.50
VC = £1.50
Calculate Caroline’s Break Even FC = £1,250
Point and also how much Profit
would she make if she sold 2,000 bunches of flowers?
Firstly, calculate Unit Contribution
SP – VC = Unit Contribution
£2.50 - £1.50 = £1.00
Now calculate Break Even
£1,250  £1.00 = 1,250 units
SP = £2.50
VC = £1.50
How much Profit would she make FC = £1,250
if she sold 2,000 bunches of flowers? Unit Cont = £1.00
Now, calculate the profit at 2,000 bunches of flowers

Unit Contribution x No of Units = Total contribution
£1.00 – 2,000 units = £2,000
Total Contribution – Fixed Costs = Net Profit

£2,000 - £1,250 = £750
Another Example
Calculate how many units need to be

produced in order to achieve a Net Profit of
£25,000 given the following information
Fixed Costs £30,000

Contribution per unit £10
Answer http://www.bized.ac.uk
Net Profit = Total Contribution – Fixed Cost

£25,000 = Total Contribution - £30,000
therefore Total Contribution = £55,000
If unit contribution is £10

then 5,500 units will have to be produced in order to
achieve a Total Contribution of £55,000.
Therefore the number of units required to achieve a Net

Profit of £25,000 is 5,500 units
Break-Even Analysis
The formulae used so far assumes that Unit
Costs are known i.e. Unit Selling Price and
Unit Variable Cost
When no unit costs are known, the

Profit/Volume Ratio should be used instead
Profit Volume Ratio http://www.bized.ac.uk
P/V Ratio (Profit/Volume Ratio) =
Total Contribution / Sales x 100
If asked to calculate the volume of sales needed to

Break-Even (when no unit costs are given) the
following formula should be used:
Sales at BEP = Fixed Costs / Profit/Volume Ratio

Profit/Volume Ratio
For Example
Sales £60,000
Variable Costs £24,000
Fixed Costs £14,000
Calculate the P/V Ratio and the BEP

Sales – Variable Costs = Total Contribution

£60,000 - £24,000 = £36,000
Total Contribution / Sales = P/V Ratio

(£36,000 / £60,000) x 100 = 60%
Fixed Costs / P/V Ratio = Sales at BEP

£14,000 / 60% = £23,333
Therefore £23,333 of Sales are necessary in order to

Break-Even
Break-Even Chart The Break-even point

occurs where total
Costs/Revenue TR TC revenue equals total
VC costs – the firm, in
this example would
have to sell Q1 to
generate sufficient
revenue (income) to
cover its total costs.
BEP
FC
Q1 Output/Sales
Break-Even Chart If the firm chose

At present, this
Costs/Revenue to set price higher
TR (p = £3) TR (p = £2) TC firms sells each
than £2 (say £3)
unit for £2 –
VC the TR curve
Break Even point
would be steeper
is at Q1
– they would not
have to sell as
many units to
break even
BEP
BEP
FC
Q2 Q1 Output/Sales
Break-Even Chart
TR (p = £1)
Costs/Revenue If the firm chose
TR (p = £2)
TC to set prices lower
VC (say £1) it would
need to sell more
BEP units before
covering its costs
BEP
FC
Q1 Q3 Output/Sales
Break-Even Chart
TR (p = £2)
Costs/Revenue TC If youunits
Any sell sold
fewer
units than
above Break theEven
Profit VC Breakrepresents
Point Even Point, a
a loss is incurred
Profit
BEP
Loss
FC
Q1 Output/Sales
Break-Even Chart Margin of

Ifhigher
weshows
Asafety sell
TR (p = £3) TR (p = £2)
TC Break
more
how far Even
than
sales can
Costs/Revenue price would
fall before
Point
Break losses
isEven
Q1
VC lower the
are made. If Q1
=Point
break ie Q2
1000even
units
weand
point
sold start to=
andQ2the
make
1800,
margin a could
sales
of
fall by 800 units
Profit
safety
before awould
loss
BEP widen
would be made
Margin of Safety
FC
Q3 Q1 Q2 Output/Sales
LIMITING FACTORS http://www.bized.ac.uk
• Under normal circumstances, the best-

paying product is that which shows the
highest contribution per £ of sales
• Certain circumstances make this
inappropriate eg
• a factory producing a particular range of
products may depend on a highly skilled
labour force
• If skilled labour is in short supply in the
locality of the factory, then labour is
termed a limiting, or key, factor
LIMITING FACTORS http://www.bized.ac.uk
• The most important criterion now will be

the optimum use of labour
• This is expressed by the contribution per
labour hour
• Direct labour is only one example of a
limiting factor
• Other examples could be
– direct materials
– machine hours
– factory capacity
For Example http://www.bized.ac.uk
• In a situation where labour is scarce (ie

direct labour = limiting factor), advise
management which of Products X and Y is
more profitable
Product XProduct Y
Selling Price £100 £100
Contribution %
(P/V Ratio) 35% 30%
Direct Labour
Hours per unit 25 hours 20 hours
Under normal circumstances Product X would

be the better paying product because of its
higher P/V Ratio
However, when the limiting factor is labour,
Product Y becomes the better paying
product:
Product X Product Y
Contribution Per Direct 35% x £100 30% x £100
Labour Hour
25 20
= £1.40 = £1.50
PRODUCT MIX http://www.bized.ac.uk
A business may produce a number of products but at

the same time be unable to meet total demand for
all products due to a limiting factor eg machine
hours or labour hours.
In this case the business would decide on the
optimum use of the limited resource by producing
all of the demand for the product which yields the
highest contribution per the limiting factor.
Having produced all of the demand from that
product, the business would produce the next
highest contribution per the limiting factor and so
on until full capacity is reached.
For example http://www.bized.ac.uk
A business can produce Products A, B and C.

A B C
Contribution per labour £2 £1 £3
hour
Labour hours per unit 4 4 3
Total demand in units 5,000 5,000 10,000
The factory is limited to 60,000 labour hours.

How many units of each Product should be produced
to maximise profit?
Produce in the order of the highest Contribution

per Labour Hour ie C then A then B
C A
Demand 10,000 5,000
Labour hrs/unit 3 4
Total lab hrs 30,000 20,000
Total labour hours required to produce all demand for

C then A = 50,000 labour hours.
If Total Labour hours available equals 60,000

and 50,000 is used producing Products C
and A, then 10,000 labour hours are left to
produce as many units as possible for
Product B
Product B uses 4 labour hours per unit,
therefore only 2,500 units of Product B can
be produced within the available 60,000
labour hours
Assumptions of Break Even

Analysis
• All Fixed and Variable costs can be
identified
• Variable costs are assumed to vary
directly with output
• Fixed costs will remain constant
• Selling prices are assumed to remain
constant for all levels of output
Assumptions Continued
• The sales mix of products will remain

constant – break even charts cannot
handle multi-product situations
• It is assumed that all production will be
sold
• The volume of activity is the only
relevant factor which will affect costs
Limitations of Break Even http://www.bized.ac.uk
Analysis
• Some costs cannot be identified as precisely
Fixed or Variable
• Semi-variable costs cannot be easily
accommodated in break-even analysis
• Costs and revenues tend not to be constant
• With Fixed costs the assumption that they
are constant over the whole range of output
from zero to maximum capacity is unrealistic
Limitations Continued http://www.bized.ac.uk
• Price reduction may be necessary to

protect sales in the face of increased
competition
• The sales mix may change with changes
in tastes and fashions
• Productivity may be affected by strikes
and absenteeism
• The balance between Fixed and Variable
costs may be altered by new technology

Break-Even Analysis Is Used To

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Break-Even Analysishttp://www.bized.ac.

Variable costs are costs that change with changes in production

Fixed costs remain roughly the same regardless of sales/output

The Break-even point occurs when Total Costs equals

Revenues (Sales Income) = Total Costs

Let us have a look at a simple example.

Bannerman Trading Company

• We must firstly calculate how much income from

This is called the Unit Contribution.

This is called the Break Even Point

Therefore 400 bunches of flowers must be sold to Break

Lets try another example:

First calculate the Unit Contribution VC = £2.00

SP – VC = Unit Contribution FC = £300

£5.00 - £2.00 = £3.00

Now calculate Break Even point by using the

Lets try another example:

How many units must be sold in order to Break

First calculate the Unit Contribution VC = £3.00

SP – VC = Unit Contribution FC = £1,200

£6.00 - £3.00 = £3.00

Now calculate Break Even point by using the

Break Even can also be used to calculate Profit (or Loss)

Each Golf Club is sold for £20

She buys each bunch of flowers for £1.49 and

Now, calculate the profit at 2,000 bunches of flowers

Total Contribution – Fixed Costs = Net Profit

Calculate how many units need to be

Fixed Costs £30,000

Net Profit = Total Contribution – Fixed Cost

therefore Total Contribution = £55,000

If unit contribution is £10

Therefore the number of units required to achieve a Net

When no unit costs are known, the

P/V Ratio (Profit/Volume Ratio) =

Total Contribution / Sales x 100

If asked to calculate the volume of sales needed to

Sales at BEP = Fixed Costs / Profit/Volume Ratio

Calculate the P/V Ratio and the BEP

Sales – Variable Costs = Total Contribution

Total Contribution / Sales = P/V Ratio

Fixed Costs / P/V Ratio = Sales at BEP

Therefore £23,333 of Sales are necessary in order to

Break-Even Chart The Break-even point

Break-Even Chart If the firm chose

Break-Even Chart Margin of

• Under normal circumstances, the best-

• The most important criterion now will be

• In a situation where labour is scarce (ie

Under normal circumstances Product X would

A business may produce a number of products but at

A business can produce Products A, B and C.

Total demand in units 5,000 5,000 10,000

The factory is limited to 60,000 labour hours.

Produce in the order of the highest Contribution

Total lab hrs 30,000 20,000

Total labour hours required to produce all demand for

If Total Labour hours available equals 60,000

Assumptions of Break Even

• The sales mix of products will remain

• Price reduction may be necessary to

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