3.

3 Break-even analysis
 Break-even analysis
• LO: Conduct a break-even analysis
Starter
• Give at least one example of each of the following costs;
• Fixed costs
• Variable costs
Extension: State 2 positives and 2
• Direct costs
drawbacks of using Breakeven calculations.
• Indirect costs
• Semi variable costs

All: Define breakeven and contribution (level 1-2)

Most: Calculate breakeven point and draw a breakeven graph (level 3-
5)
Some: Evaluate the suitability of breakeven as an analysis tool (level 6-
7)
 Contribution
• Contribution refers to the sum of money that remains after all direct and
variable costs have been taken away from sales revenue.
 Contribution
• Contribution analysis helps a business to identify which products are relatively
profitable.

• Uses of contribution analysis

• Setting pricing strategy
• Product portfolio management Activity
Identify the most and least
• Allocation of overheads to cost and profit centers
profitable products.
• Make or buy decisions Why does to company continue to
• Special order decisions sell all of the products?
 Breakeven analysis
A breakeven analysis shows you the level of sales requires to cover all of
your costs.
Three methods used to calculate breakeven
1. TR = TC rule
2. Contribution per unit rule
3. Interpretation of BE graph
 Breakeven analysis (TR = TC rule)
Total Revenue = Total Cost
(Price X Quantity) = (Fixed costs + Variable costs)

Activity
A handbag retailer has fixed
costs of $3,500 per month.
This answer is in number of handbags
Variable costs per unit are $10. required to breakeven.
selling price is $30. How would we calculate the breakeven
revenue required?
Breakeven analysis (Contribution per unit
method)
Fixed costs ÷ Contribution per unit
Fixed costs ÷ (Price – Average variable costs)

Activity
A handbag retailer has fixed costs
of $3,500 per month. Variable costs
per unit are $10. selling price is
$30.
Extension – calculate the breakeven revenue
 Breakeven analysis (analysis of graph)
Label the following graph
Total costs
Fixed costs
Activity
A handbag retailer has Total revenue
fixed costs of $3,500 Profit
per month. Variable
costs per unit are $10. Loss
selling price is $30. Breakeven point
 How to construct a breakeven graph
1. Draw and label each axis (output & Costs and revenue)
2. Put a title on the graph
3. Draw and label the FC line
4. Calculate the BE Quantity and Revenue
5. Draw the TR line by connecting zero to the breakeven point (using a ruler)
6. Draw the TC line by connecting the point where FC starts to the breakeven point
(using a ruler)
7. Label BE point, Profit, Loss and margin of safety
Breakeven analysis
 Margin of safety
• The margin of safety (MOS) measures
the difference between a firm's sales
volume (units) and the quantity needed
to break-even.
• A positive margin of safety indicated a
profit and a negative margin of safety
indicates a loss.
 Breakeven point (target profit)
Activity
A handbag retailer has
fixed costs of $3,500 per
Businesses usually will not be satisfied to just breakeven. They might also
month. Variable costs
per unit are $10. selling
want to include a target profit in their calculation of breakeven.
price is $30. Total Revenue = Total Cost
(Price X Quantity) = (Fixed costs + Variable costs + Target profit)
The business aims to
make a target profit of
$5,000

Extension
Draw the breakeven
graph and label it fully
 Advantages and disadvantages of breakeven
Advantages
• Focuses business on what output or total
sales is required
• Helps understand the viability/risk of a
business proposition
• Can be used to gain access to finance
• Illustrates the importance of a start-up
keeping fixed costs down to a minimum
• Calculations are quick and easy – great for
giving quick estimates
Disadvantages
• Unrealistic assumptions – products are not sold at the same
price at different levels of output; fixed costs do vary when
output changes; other factors not taken into consideration
(motivation)
• Sales are unlikely to be the same as output
• Doesn't take into accounts wastage
• Variable costs do not always stay the same(economies of
scale).
• Most businesses sell more than one product, so break-even
for the business becomes harder to calculate
• Accuracy depends on reliability of data
Additional past paper
questions