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3.3. Break-even Analysis Summary

  • Note:

    • Total contribution = Total revenue – Total variable cost
    • Contribution per unit = Price per unit – Variable cost per unit
  • Break-even analysis
    • BEQ is quantity when all are equalBreak-even point
      • Intersection of Total Cost and Total Revenue in a Break Even Chart
      Margin of safety
      • Shows how much demand exceeds or fails to exceed BEQSales volume (Projected Demand) – BEQEvaluate degree of risk based on demand for a product
      • Can be expressed as a percentage of demand
      Target profit and revenue
      • Can be used to calculate level of sales needed to attain a certain profit
      • Ignores other factors that affect profit:
        • Different pricing throughout time
        • Level of demand is subject to change
        • Profit depends on risk
        • Innovation and luck – prediction aren’t always followed
        Must consider:
        • Pricing strategies (penetration pricing, market skimming, etc.)Price elasticity
      Break-even is when total costs equal total revenue helps to tell whether a good can be financially worthwhile and the level of profit a business is likely to earn
    • Break-even quantity
      • Minimum level of sales before the firm could break even
      • When Total revenue  = Total fixed cost + [Total variable cost x Quantity]
  • Break-even chart
    • Title : Break-Even Analysis for Company XYZLabel Axes:
      • X-axis is output Y-axis is Revenue/Cost (label currency as well)
      Determine max. output and mark it, as well as revenue from this level of output
      • If maximum isn’t given, make it twice the BEQ
      Determine BEQ and draw a vertical line at that point
      • Mark the revenue gained from this quantity on the line (Break Even Point)
      Draw Total Fixed Cost line
    • Draw Total Cost line
      • starts at TFC at x=0, intersects the BEP
    • Draw Total Revenue line
      • starts at (0,0), intersects BEP
  • Limitations
    • Makes several assumptions:
      • Fixed costs must be paid regardless of output
      • Variable cost increases linearlyIgnores economies of scale
      • Sales revenue increases linearly
        • Ignores discounts for large orders and price discrimination
        Assumes only one product is sold
      • Every unit of output is sold
      • Selling price is constant regardless of units sold
      Provides a static model (e.g. production costs can change) Depends on reliability of data
    • Other factors can have an effect (e.g. competitors, staff motivation)
    • Only suitable for single-product firms

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