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Break even analysis

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  • 1. Craig DuddenBreak Even Analysis
  • 2. Craig Dudden• …determines the point at whicha business neither makes aprofit or loss.• …all costs are covered by aparticular volume of output
  • 3. Craig DuddenMp3 PlayerExpected selling price£150Direct costs(variable costs)Indirect costs(Fixed costs)Direct materialsDirect labourDirect expenses£50£30£20£100Factory rent£50,000 p.a(per annum)a) Contribution per unit = Selling price - Variable costs£50 = £150 - £100b) Break Even Point is calculated by:c) at BEP: Total Costs = Total Revenue(1,000 units x VC £100)+ FC £50,000 = 1,000 units x SP £150£150,000 = £150,000£50,000£50= 1,000 units
  • 4. Craig DuddenOver to You
  • 5. Craig Dudden
  • 6. Craig DuddenBreak Even Chart• Takes considerable time to work out the BEP usingthis method.0250 500 750 1000 15001250225,000200,000175,000150,000125,000100,00075,00050,00025,000Fixed costs (FC)Variable costs (VC)Total Revenue (TR)Total Costs (TC)Volume or Output (units)Cost,Revenue(£)
  • 7. Craig DuddenUses of Break Even Analysis• Break even analysis is particularuseful when making decisionsregarding the launch of newproducts or services, ordiversification into new markets.• When launching a new productit is important to know the levelof output and sales needed tobreak even. This can becalculated by dividing fixedcosts by contribution per unit.
  • 8. Craig DuddenMargin of Safety• From the break even quantity we can calculate the excess ofsales over break even. This is known as the margin of safety. Theformula is: actual output minus break even output. The higherthe margin of safety is, the greater the profits. In fact, think of it interms of once break even has been reached, each unitcontribution now adds to the firm’s profits.• If we multiply the margin of safety by contribution per unit weget the level of profits.Profit = margin of safety X contribution per unitWe can vary the formula to calculate the level of output neededto achieve a target level of profits. What we do here is to addthe profit target to fixed costs and the simply work out thenumber of unit contributions needed to achieve this level ofprofit. Thus, the formula is:Fixed costs + profit targetContribution per unit
  • 9. Craig DuddenSummaryAt the break even level of output andsales (note only when the output is solddoes it contribute to sales revenue), iswhen the firm is neither making a profitnor a loss. It is when sales revenue coverscosts, but no more than that.Logically, if output and sales are belowthe break even level then the firm ismaking a loss, whereas if output and salesare above the break even level then it ismaking a profit. The higher the level ofoutput and sales above break even, thegreater the profit.
  • 10. Craig DuddenSummaryAt the break even level of output andsales (note only when the output is solddoes it contribute to sales revenue), iswhen the firm is neither making a profitnor a loss. It is when sales revenue coverscosts, but no more than that.Logically, if output and sales are belowthe break even level then the firm ismaking a loss, whereas if output and salesare above the break even level then it ismaking a profit. The higher the level ofoutput and sales above break even, thegreater the profit.