break even analysis

• Break Even analysis


  A business management tool that helps to determine the appropriate level of sales
• Constructing a Break Even chart

  1. Calculate Break Even quantity, costs and revenues

  2. Draw the axes, total fixed costs, total costs and total revenues lines

  3. Label the chart

  4. Indicate Break Even point, Break Even quantity, profit and loss
• Break Even chart


  • Illustrates the value of cost and revenues against the volume of output
  • Shows the Break Even point where total revenue equals total costs
• Break Even quantity


  The number of items that an organization needs to sell in order to break even
• Break Even point


  The point on the Break Even chart where total revenue and total costs intersect
• Calculating Break Even quantity

  1. Using the formula: Total fixed costs / (Price - Average variable costs)

  2. Using the formula: Total fixed costs / Contribution per unit

  3. Using the Break Even chart to find the intersection of total revenue and total costs
• Profit


  The positive difference between total revenue and total costs
• Loss


  The negative difference between total revenue and total costs
• Margin of safety


  The difference between the actual/expected level of output and the Break Even quantity
• Target profit output


  The level of output required to achieve a target profit
• Target profit


  The desired level of profit
• Target price


  The price required to achieve a target profit
• Break-even point


  The point where total revenue (TR) equals total cost (TC), and there is no profit or loss
• When output is to the right of the break-even point

  There is profit
• When output is to the left of the break-even point


  There is loss
• Profit


  The difference between total revenue (TR) and total cost (TC)
• Margin of safety


  The difference between the break-even quantity and the actual sales
• The greater the margin of safety, the better, as it means profits will be higher and the organization is less sensitive to fluctuations in demand
• Calculating margin of safety

  1. Subtract break-even quantity from actual sales

  2. Express as a percentage of break-even quantity or actual sales
• Target profit output


  The level of quantity or output required to reach the desired profit
• Calculating target profit output

  1. Use break-even chart

  2. Use formula: (Total fixed costs + Target profit) / Contribution per unit

  3. Use profit formula: Total revenue - Total cost
• Target profit


  The desired profit at the target profit output level
• Target price


  The price required to achieve the target profit level
• Calculating target profit and target price

  Use the same formulas as for target profit output, but alter the variables
• Break-even analysis is a helpful decision-making tool, but it is simplified and static, not representative of the dynamic reality
• Break-even analysis is most useful in stable industries, less so in fast-changing environments
• Break-even analysis helps with pricing strategy, determining production levels, cost management, and setting target profits and prices
• Changes in price, fixed costs, and variable costs affect break-even quantity, profit, and margin of safety
• The effects can be determined quantitatively by altering the formulas or graphically by drawing new break-even charts