Break Even Analysis

• Break Even is the point at which the business is not making a profit or a loss
• At Break Even point total costs must be the same as total revenue
• Break Even output is the number of items that a business must sell to reach this point
• Before reaching Break Even a business is operating at a loss
• After reaching Break Even each additional unit sold will contribute towards profit
• Money generated from revenues firstly has to pay for variable costs and then contributes towards fixed costs
• Until there is enough contributions to cover all the fixed costs the business can’t make any profit
• Each time a product is sold the difference between selling price and variable costs is contributed towards the fixed costs
• Contribution per unit is the difference between selling price per unit and variable cost per unit
• Contribution = selling price - variable cost
• Total contribution is the difference between total sales revenue and total variable costs
• Total contribution = Total Revenue - Total Variable Costs
• Contribution per unit can be used to calculate break even
• Fixed cost / contribution = Break Even output
• Margin of Safety is how much actual output is above the break even level of output
• Margin of safety = Actual output level - break even level of output
• Break Even Charts are an alternative way of calculating the Break Even point.
• Businesses should treat break-even with a degree of caution.
• Break Even is based on the assumption that costs and revenues will remain the same.
• Fixed Costs can change: Landlords put up rent, Bank changes interest rates and management want a pay increase
• Variable costs can change: Raw materials can change in price, Minimum wage increases and Utility companies can change prices
• Selling Price can change: New competition can enter market, demand can increase
• Strength of Break Even: Allows business to calculate the minimum number of sales needed to make a profit, Aids decision making and is integral to business plan when seeking to secure finance
• Weaknesses of Break Even: Is based on predicted costs and revenues, Fixed costs can vary in reality and Changes in variable costs and selling price (Eg. Items bought or sold in larger quantities).