Download break-even point

IB Business Management
UNIT: 5.3 – Break-even
Analysis pg. 642
 Understand/practice break-even analysis
& margin of safety
Fixed or Variable?
Direct or Indirect?
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Rent
Wages
Salaries
Materials
Insurance
Commission
Utilities
Breaking Even
Business can be in one of the following
financial situations:
• Loss: costs exceeds revenue
• Break-Even: costs equal revenue
• Profit: revenue exceeds costs
Breaking Even
• Break-even point exists where a
business makes neither profit nor loss
• This occurs at the level of output
where total costs equal total revenue
• Typically a goal of new firms
Contribution
 What
is the purpose of calculating
contribution? Unit contribution = P - AVC
 Any product w/ a positive contribution will
help pay some of the FC of the company
 Contribution analysis gives 3 ways profits
can be improved:
 Increase sales revenue
 Reduce VC
 Reduce FC
Meaning of Break-Even Point
• Total Costs = Total Revenue when
output reaches the break-even point
• Any sales above the break-even
quantity will generate a profit
• Sales below the break-even level will
yield a loss
Break-even Analysis
 A business
can only survive in the
long run if revenue > costs
 New firms especially want to
determine the level of sales needed
to generate a profit
Break-Even Analysis
Two purposes for conducting a breakeven analysis, which helps determine:
• If its financially worthwhile to produce
a particular good or service (such as
introducing a new product)
• Amount of profit that business is likely
to earn if things go according to plan
Break-Even Analysis
Example
• Jeans retailer has fixed costs of
$2,500 per month
• Each pair of jeans sells for $30
• $10 in variable costs per pair of jeans
• What is the break-even point?
Calculating Break-Even Point
Method 1
Identify where total costs equal total
revenue on a break-even chart
• The break-even point is the position
where the total cost line intersects the
total revenue line (TC=TR)
Calculating Break-Even Point
Method 2
Using the TC = TR rule:
• TFC + TVC = Price x Quantity
• 2500 + 10(Q) = 30Q
• 2500 = 20Q
• 125 = Q (pairs of jeans)
Calculating Break-Even Point
Method 3
Unit contribution is difference between
a product’s price and variable cost
• Contribution = Price – VC
• Break-Even Point = TFC / Unit Contribution
$2500
= 125 pairs
$30-10
Break-Even Example
Use the unit contribution method to
calculate the break-even quantity for a
firm that has the following financials:
• TFC = $200,000
• AVC = $5
• Price = $30
P - AVC = unit contribution
Break-even = fixed costs
unit contribution
Margin of Safety
Measures difference between firm’s
current sales quantity & break-even point
• Positive margin means that firm is
making a profit
• Always shown in units, not dollars!
Safety margin = level of demand – breakeven qty.
Margin of Safety Example
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Demand for jeans is 200 pairs per month
Break-even point is 125 pairs per month
Safety margin is 75 units (200-125 = 75)
This means the business can sell 75
fewer pairs of jeans before losing money.
Constructing a Break-even Chart
 Rules
to follow when constructing BE chart:
 Draw/label TFC line
 Draw/label TC line. Q = 0; TC start at ???
 Draw/label TR line. Q = 0; TR starts at
???
 X-axis is labeled as “Output” or units
 Y-axis is labeled as “Costs, Revenues,
Profit” $$$