BreakEven
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Break-even analysis is used to predict future profits and losses and determine the break-even point, where total revenue equals total costs. There are two types of costs - variable costs that change with production and fixed costs that remain constant. To calculate break-even point, total costs (fixed + variable) are set equal to total revenue. This point is illustrated with a break-even chart and shows the quantity that must be sold to cover total costs without profit or loss. Above this point are profits and below are losses. Assumptions of the analysis include constant prices and costs and that all production will be sold. Limitations include difficulty identifying some cost types and assumptions of stability.
BreakEven
- 1. http://www.bized.ac.uk Break Even Analysis Sagar Patel
- 2. http://www.bized.ac.ukBreak Even Analysis • Break-Even Analysis is used to – predict future profits/losses – predict results eg 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 firm merely covers its total costs • Break-Even Point can be shown in graph form or by use of formulae
- 3. http://www.bized.ac.uk 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 In order to calculate how profitable a product will be, we must firstly look at the Costs involved - Break-Even Analysis
- 4. http://www.bized.ac.uk Break Even Analysis • 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.
- 5. http://www.bized.ac.uk The Break-even point occurs when Total Costs equals Revenue (Sales Income) Revenues (Sales Income) = Total Costs Break-Even Analysis At this point the business is not making a Profit nor incurring a Loss – it is merely covering its Total Costs
- 6. http://www.bized.ac.ukBreak-Even Chart Costs/Revenue Output/Sales FC VC TCTR The Break-even point occurs where total revenue equals total costs – the firm, in this example would have to sell Q1 to generate sufficient revenue (income) to cover its total costs. Q1 BEP
- 7. http://www.bized.ac.uk Break-Even Chart Costs/Revenue Output/Sales FC VC TCTR (p = 2) Q1 If the firm chose to set price higher than 2 (say 3) the TR curve would be steeper – they would not have to sell as many units to break even TR (p = 3) BEP Q2 BEP At present, this firms sells each unit for 2 – Break Even point is at Q1
- 8. http://www.bized.ac.ukBreak-Even Chart Costs/Revenue Output/Sales FC VC TCTR (p = 2) Q1 If the firm chose to set prices lower (say 1) it would need to sell more units before covering its costs TR (p = 1) BEP Q3 BEP
- 9. http://www.bized.ac.ukBreak-Even Chart Costs/Revenue Output/Sales FC VC TCTR (p = 2) Q1 Loss Profit Any units sold above Break Even Point represents a Profit If you sell fewer units than the Break Even Point, a loss is incurred BEP
- 10. http://www.bized.ac.uk Costs/Revenue Output/Sales FC VC TCTR (p = 2) Q1 Q2 If we sell more than Break Even Point ie Q2 we start to make a Profit Margin of Safety Margin of safety shows how far sales can fall before losses are made. If Q1 = 1000 units sold and Q2 = 1800, sales could fall by 800 units before a loss would be madeTR (p = 3) Q3 A higher price would lower the break even point and the margin of safety would widen Break Even Point is Q1 BEP Break-Even Chart
- 11. http://www.bized.ac.uk Assumptions of Break Even Analysis • 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
- 12. http://www.bized.ac.ukAssumptions Continued • The sales mix of products will remain constant – break even charts cannot handle multi- product situations • It is assumed that all production will be sold • The volume of activity is the only relevant factor which will affect costs
- 13. http://www.bized.ac.uk Limitations of Break Even Analysis • Some costs cannot be identified as precisely Fixed or Variable • Semi-variable costs cannot be easily accommodated in break-even analysis • Costs and revenues tend not to be constant • With Fixed costs the assumption that they are constant over the whole range of output from zero to maximum capacity is unrealistic
- 14. http://www.bized.ac.uk Limitations Continued • Price reduction may be necessary to protect sales in the face of increased competition • The sales mix may change with changes in tastes and fashions • Productivity may be affected by strikes and absenteeism • The balance between Fixed and Variable costs may be altered by new technology