Break even analysis

• Breakeven analysis


  A financial tool used by businesses to determine the point at which total revenue equals total costs, resulting in neither profit nor loss

  
• Breakeven point


  The level of sales or production volume at which a business covers all its expenses but doesn't make any additional profit

  
• Costs associated with producing goods or providing services

  • Fixed costs
  • Variable costs
• Fixed costs


  Expenses which remain constant regardless of the level of production or sales
• Variable costs


  Expenses which fluctuate in direct proportion to changes in production or sales volume

  
• Advantages of Breakeven Analysis

  • Simplicity
  • Facilitates Cost Control
  • Supports Decision-Making
  • Enhances Performance Monitoring
  • Encouraging Accountability and Transparency
• Assumptions of Breakeven Analysis

  • All costs can be classified into variable cost per unit and total fixed cost
  • Variable cost per unit remains constant
  • Total fixed cost remains constant
  • Selling price per unit remains constant
  • All units produced are sold and there is no inventory
  • Capacity remains the same

  
• Calculation of Breakeven Point

  1. Identify fixed and variable costs

  2. Calculate contribution margin per unit

  3. Determine total fixed costs

  4. Calculate breakeven point in units

  5. Calculate breakeven point in sales revenue
• Activity 1: Calculating Breakeven Point


  Breakeven point in units

  2. Breakeven point in sales

  3. Units to be sold to make a target profit of $80,000

  4. The level of sales that will achieve a target profit of $80,000
• Breakeven Chart


  The graphical representation of the breakeven point
• Margin of Safety


  The amount by which sales exceed the breakeven point, providing insight into the level of sales cushion available to cover unexpected downturns or fluctuations in business activity
• Calculating the Margin of Safety

  Margin of Safety = Actual Sales (or Projected Sales) - Breakeven Sales
• Interpreting the Margin of Safety

  A positive margin of safety indicates that actual or projected sales exceed the breakeven point, providing a buffer against unexpected downturns in sales or changes in market conditions.

  A negative margin of safety suggests that actual or projected sales are below the breakeven point, indicating that the business is operating at a loss.

  
• Activity 2: Calculating Breakeven Point and Margin of Safety


  The Breakeven Point

  1. The Margin of Safety
  2. Interpret the Margin of Safety
  3. Express The Margin of Safety as a percentage of Sales
• Activity 3: Plotting a Breakeven Chart


  Plot a well-labelled breakeven chart

  2. Determine the margin of safety and illustrate this on the chart
• Make or Buy Decisions

  Evaluating whether it is more cost-effective for a business to produce a product or service internally (make) or to purchase it from an external supplier (buy)

  
• Factors influencing the make or buy decision

  • The cost involved

  The firm may be the only one producing the product

  The firm may want to produce its own brand

  The firm may want to ensure product availability

  The reputation of the firm may be placed on the line
• Homework Assignment: Textbook - Management of Business for CAPE Examinations, Jerome Pitterson, Page 223, Extended Essay Question, parts 'a' and 'b' ONLY (19 marks)