http://www.bized.ac.

uk

Break-Even
Analysis
 Break-Even Analysishttp://www.bized.ac.uk

• Break-Even Analysis is used to

– predict future profits/losses
– predict results e.g produce Product A or Product B
• Break-Even Point is when Sales Revenue equals Total
Costs
• At this point no profit or loss is incurred
• The level of sales at which the company’s profit is zero
• The firm merely covers its total costs
• Break-Even Point can be shown in graph form or by
use of formula
 Break-Even Analysishttp://www.bized.ac.uk
In order to calculate how profitable a product will be, we must
firstly look at the Costs involved -
There are two basic types of costs a company incurs.
• Variable Costs
• Fixed Costs
Variable costs are costs that change with changes in production
levels or sales. Examples include: Costs of materials used in the
production of the goods.

Fixed costs remain roughly the same regardless of sales/output

levels. Examples include: Rent, Insurance and Wages
 Break-Even Analysis
http://www.bized.ac.uk

• TOTAL COSTS
– Total Costs is simply Fixed Costs and Variable Costs
added together.

TC = FC + VC
– As Total Costs include some of the Variable Costs then
Total Costs will also change with any changes in
output/sales.
– If output/sales rise then so will Total Costs.
– If output/sales fall then so will Total Costs.
 Break-Even Analysis http://www.bized.ac.uk

The Break-even point occurs when Total Costs equals

Revenue (Sales Income)

Revenues (Sales Income) = Total Costs

At this point the business is not making a Profit nor
incurring a Loss – it is merely covering its Total Costs

Let us have a look at a simple example.

Bannerman Trading Company

opens a flower shop.
 Break-Even Analysis http://www.bized.ac.uk

Fixed Costs:
• Rent: P400
• Helper (Wages): P200
Variable Costs:
• Flowers: P0.50 per bunch
Selling Price:
• Flowers: P2 per bunch
So we know that:
Total Fixed Costs = P600
Variable Cost per Unit = P0.50
Selling Price per Unit = P2.00
 Break-Even Analysis http://www.bized.ac.uk

SP = P2.00 VC = P0.50 FC = P600

• We must firstly calculate how much income from each bunch

of flowers can go towards covering the Fixed Costs.

This is called the Unit Contribution Margin.

Selling Price – Variable Costs = Unit Contribution

P2.00 - P0.50 = P1.50
• For every bunch of flowers sold P1.50 can go towards covering
Fixed Costs
 Break-Even Analysis http://www.bized.ac.uk

SP = P2.00 VC = P0.50 Unit contribution Margin = P1.50 FC = P600

Now to calculate how many units must
be sold to cover Total Costs (FC + VC)

This is called the Break Even Point

Break Even Point =
Fixed Costs  Unit Contribution
P600  P1.50 = 400 Units

Therefore 400 bunches of flowers must be sold to Break Even – at this

the point the business is not making a Profit nor incurring a Loss – it is
merely covering its Total Costs.
 Break-Even Analysis http://www.bized.ac.uk

Lets try another example:

Selling Price per unit = P5.00
Variable Cost per unit = P2.00
Fixed Costs = P300.00

How many units must be sold in order to Break

Even?
 Break-Even Analysis http://www.bized.ac.uk

SP = P5.00 VC = P2.00 FC = P300.00

First calculate the Unit Contribution Margin

SP – VC = Unit Contribution
P5.00 - P2.00 = P3.00

Now calculate Break Even point by using the formula –

Fixed Costs  Unit Contribution Margin
P300  P3.00 = 100 units
Therefore 100 units must be sold in order to Break Even.
 Break-Even Analysis http://www.bized.ac.uk

Break Even can also be used to calculate Profit (or Loss)

at a given level of output

For example:
J Bannerman sells Golf Clubs. How much profit/loss is made when
5000 golf clubs are sold?

Each Golf Club is sold for P20

Variable Costs per golf club are P10
Fixed Costs total P24,000
 Break-Even Analysis http://www.bized.ac.uk

SP = P20.00 VC = P10.00 FC = P24,000 Sales = 5,000 units

Firstly, calculate Unit Contribution Margin:

SP – VC = Unit Contribution Margin
P20.00 - P10.00 = P10.00
Now calculate Total Contribution when 5,000 golf clubs are sold:
Unit Contribution Margin x no. of units = Total Contribution
P10.00 x 5,000 = P50,000
Now calculate Net Profit at 5,000 units:
Total Contribution – Fixed Costs = Net Profit
P50,000 - P24,000 = P26,000
 Break-Even Analysis http://www.bized.ac.uk

Another Example

Calculate how many units need to be

produced in order to achieve a Net Profit of
P25,000 given the following information:

Fixed Costs P30,000

Contribution Margin per unit P10
 Answer http://www.bized.ac.uk

Net Profit = Total Contribution – Fixed Cost

P25,000 = Total Contribution - P30,000
Total Contribution=(P25,000) + (P30,000)
= P55,000
Target Sales per Unit = P55,000
Contribution Margin per unit (P10)
therefore Target Sales per unit = 5,500 units

If unit contribution is P10 then 5,500 units will have to be produced in order to
achieve a Total Contribution of P55,000.
Therefore the number of units required to achieve a Net Profit of P25,000 is 5,500 units.
 Break-Even Analysis http://www.bized.ac.uk

The formula used so far assumes

Unit Costs are known are, Unit Selling Price
and Unit Variable Cost

When no unit costs are known, the

Contribution Margin Ratio should be used
instead.
 Contribution Margin Ratio http://www.bized.ac.uk

CM Ratio (Contribution Margin Ratio) =

Total Contribution / Sales x 100

If asked to calculate the volume of sales needed to Break-

Even (when no unit costs are given) the following formula
should be used:
Sales at Break Even Point (BEP) = Fixed Costs
CM Ratio
 Contribution Margin Ratio http://www.bized.ac.uk

For Example

Sales P60,000
Variable Costs P24,000
Fixed Costs P14,000

Calculate the CM Ratio and the BEP

 Answer http://www.bized.ac.uk

Sales – Variable Costs = Total Contribution

£60,000 - £24,000 = £36,000

Total Contribution / Sales = CM Ratio

(P36,000 / P60,000) x 100 = 60%

Fixed Costs / CM Ratio = Sales at BEP

P14,000 / 60% = P23,333

Therefore P23,333 of Sales are necessary in order to Break-Even

 Break-Even Chart http://www.bized.ac.uk

A breakeven chart is a strategic tool used to plot

the financial revenue of a business unit to
determine the point when sales output is equal to
revenue generated.
This is recognized as the Break Even Point (BEP).
The information used to determine and analyze the
breakeven point includes fixed, variable and
total costs and the associated sales revenues.
 Break-Even Chart http://www.bized.ac.uk

Costs/Revenue TR TC
VC The Break-even point
occurs where total
revenue equals total
costs – the firm, in
this example would
have to sell Q1 to
BEP generate sufficient
revenue (income) to
cover its total costs.

FC

Q1 Output/Sales
 Break-Even Chart http://www.bized.ac.uk

At present, this
Costs/Revenue Total Revenue (p = P3) firms sells each
TR (p = P2) Total Cost unit for P2 –
VC Break Even point
is at Q1

If the firm chose to set

price higher than P2 (say
P3) the TR curve would be
steeper – they would not
BEP have to sell as many units
to break even

BEP
FC

Q2 Q1 Output/Sales
 Break-Even Chart http://www.bized.ac.uk

TR (p = P1)
Costs/Revenue If the firm chose
TR (p = P2)
TC to set prices lower
VC (say P1) it would
need to sell more
BEP units before
covering its costs

BEP

FC

Q1 Q3 Output/Sales
 Break-Even Chart http://www.bized.ac.uk

TR (p = P2)
Costs/Revenue TC If youunits
Any sell sold
fewer
units than
above Break theEven
Profit VC Breakrepresents
Point Even Point, a
aProfit
loss is incurred

BEP

Loss
FC

Q1 Output/Sales
 Break-Even Chart http://www.bized.ac.uk

If we sell more
TR (p = P3) TR (p = P2)
TC than Break Even
Costs/Revenue
Point ie Q2 we
VC start to make a
Profit
A higher price
would lower the
break even point Break Even Point
is Q1
and the margin
of safety would Margin of safety shows
widen BEP how far sales can fall
before losses are made.
If Q1 = 1000 units sold
and Q2 = 1800, sales
could fall by 800 units
Margin of Safety before a loss would be
made

FC

Q3 Q1 Q2 Output/Sales
Assumptions of Break Even Analysis
http://www.bized.ac.uk

• All Fixed and Variable costs can be

identified
• Variable costs are assumed to vary
directly with output
• Fixed costs will remain constant
• Selling prices are assumed to remain
constant for all levels of output
Assumptions of Break Even Analysis
http://www.bized.ac.uk

• Inventory levels remain constant, i.e.,

production equals sales
• Volume is the only relevant factor
affecting costs
 END http://www.bized.ac.uk

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