Break-Even Analysis
Break-even analysis is a financial tool used to determine the point at which a company's total revenues equal its total costs, resulting in neither profit nor loss. It helps businesses understand the level of sales needed to cover all expenses and is crucial for decision-making, pricing strategies, and setting sales targets.
8 Key excerpts on "Break-Even Analysis"
eBook - ePub- Nathalie Evans, Michael Jeffrey, Susan Craig(Authors)
- 2020(Publication Date)
- Bloomsbury Visual Arts(Publisher)
...10 Break-Even Analysis Introduction This chapter focuses on Break-Even Analysis and uses the same classification of costs as the previous chapter on marginal costing. Indeed, it is an extension of the marginal costing and the use of the fixed and variable cost concept. The objective of Break-Even Analysis is to establish the point at which the business will reach its break-even point. The break-even point is the point at which the business will make neither a profit nor a loss – the revenues will exactly cover the costs. In the short term, this is a useful piece of information as it gives management an understanding of what level of business that they need to achieve to at least cover their costs. Beyond the break-even point the business will go into profit; thus the sooner the business passes through its break-even point, the sooner it will become profit earning. Establishing the break-even point There are a number of ways in which the break-even point can be established: 1.By tabulating the output, costs and revenues of the business and seeing where the break-even point will fall in the table. 2.By construction a break-even chart and graphically establishing where the break-even point falls or a variation on this like a profit/volume chart. 3.By calculating the break-even point. Break-even tabulation The tabulation essentially matches the fixed costs and the variable costs at different levels of output with the revenues generated at those levels of output. Example Morning Breaks Ltd have received an order to make 5,000 dresses and the customer is prepared to pay £15 for each dress making the total order worth £75,000. The fixed costs for the period are as follows: £ Rent 9,000 Business rates 1,200 Loan interest 250 Insurance 300 Other fixed costs 1,250 Total £12,000 The variable costs of making the dresses are as follows: £.p Direct materials 6.00 Direct...
eBook - ePubProduction Economics
Evaluating Costs of Operations in Manufacturing and Service Industries
- Anoop Desai, Aashi Mital(Authors)
- 2018(Publication Date)
- CRC Press(Publisher)
...12 Break Even and Benefit Cost Analysis 12.1 What Is Break Even Analysis? Break even analysis is a very important tool that is commonly used in economic decision making. The essence of break even analysis is that in every business scenario, there will be a situation wherein the total cost incurred in producing a product or offering a service will invariably be offset by the total revenue obtained from selling it. This scenario is referred to as break even. “Breaking even” occurs when the total cost is equal to total revenue implying that neither any profit nor loss is incurred. It can also be used to compare process costing between different alternative processes. Break even analysis is used for a variety of economic evaluations such as: • To compare different processes of manufacturing in order to determine the most economical option at various production levels. • Once the production run (level) has been determined, it is necessary to establish the minimum selling price of the product. Break even analysis is helpful in this evaluation. If revenue is equal to total production cost, then the minimum selling price of the product will have to be equal to total production cost (which is equal to revenue at break even production levels) divided by the number of units produced (production run). • To determine the actual number of units that has to be produced so that total revenue will be equal to total cost. This production run is referred to as break even point. It will be obvious from the preceding discussion that in order to use break even analysis, it is essential to be able to correctly evaluate total cost of production. We have already dealt with this concept in previous chapters. In Chapter 2, we dealt with cost estimation, in Chapter 3, we dealt with material costing, Chapter 4 considered process costing and overhead costs and capital expenses were dealt with in Chapters 5 and 6...
- Michael Chibili(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...Some authors do even use the terms interchangeably. Breakeven analysis relates to the determination of a single point (the breakeven point) at which no gains or losses will be made in a business. The breakeven point is consequently the point at which the net income is exactly equal to zero. At this point, all the costs or expenses and revenue are equal. With breakeven analysis, the margin of safety is calculated, which is the amount that revenues exceed the breakeven point. The margin of safety is the amount by which revenues can fall while still staying above the breakeven point. The structure of the subsections is as follows: 11.3.1 Establishing the breakeven point 11.3.2 Single service analysis 11.3.3 Other considerations in breakeven analysis 11.3.1 Establishing the breakeven point Breakeven analysis is a supply-side analysis which only analyzes the costs of the sales excluding any analysis on how demand may be affected at different price levels. The breakeven point can be expressed as an equation as. follows: Profit = total revenue − total costs = zero This equation can be broken down into its constituent elements as follows: 0 = (X×S) -{ (V×X) +F}=P in which : X = quantity sold S = sales price V = variable cost F = fixed cost P = profit This can be further simplified to: 0 = SX−VX−F in which: SX = total revenue VX = total variable cost Assuming a situation of the sale of a single product, the equation can be rearranged to solve for any one of its four variables as follows: Assuming a situation of the sale of a single product, the equation can be rearranged to solve for any one of its four variables as follows: Fixed costs at breakeven: F =. SX−VX Variable cost per unit at breakeven: V=S− F X Selling price at breakeven: S= F X +V Quantity sold at breakeven: X= F S−V The best way to understand the breakeven analysis is by using examples and for this purpose multiple considerations will be made...
eBook - ePubReturn on Investment Manual
Tools and Applications for Managing Financial Results
- Robert Rachlin(Author)
- 2019(Publication Date)
- Routledge(Publisher)
...16 How to Use Break-Even Techniques for ROI Decision Making A business must know what volume of activity is needed to cover all expenses over and above the cost directly associated with the product and/or company activity. To put it another way, how many dollars of sales are needed to cover the company’s fixed costs? At this point, revenues generated and costs incurred are equal, and neither a profit nor a loss will materialize. When this occurs, the results are said to be at the break-even point, that is, the point where variable costs and fixed costs equal net sales dollars. This concept can be expressed in numerical terms by the use of formulas or graphically by the use of a break-even chart. In any case, the shifts or changes in revenues and costs are ultimately reflected in the operations of the business, as well as in the return on investment objectives. Thus Break-Even Analysis can be an important tool in managing the business by providing the necessary information for effective decision making. It can aid in making decisions in pricing, financing, capital investments, setting ROI objectives, and other decisions where volume, cost, price, and profits are factors. Nevertheless, certain conditions have to be assumed when using this technique. Because various volume levels will be used to show the influence on the break-even point, it is assumed that changing sales volume will not have any effect on the per unit selling price. It is also assumed that both types of expenses, variable and fixed, will react differently...
eBook - ePub- Jae K. Shim, Joel G. Siegel, Allison I. Shim(Authors)
- 2011(Publication Date)
- Wiley(Publisher)
...Under this approach, instead of a single break-even point, one calculates a probability of breaking even. Probabilities can also be used in such areas as cost variance investigation, budgeting, and capital budgeting—to name a few. Assumptions Underlying Break-Even Contribution Margin Analysis The basic break-even and contribution margin models are subject to six limiting assumptions. They are: 1. The selling price per unit is constant throughout the entire relevant range of activity. 2. All costs are classified as fixed or variable. 3. The variable cost per unit is constant. 4. There is only one product or a constant sales mix. 5. Inventories do not change significantly from period to period. 6. Volume is the only factor affecting variable costs. Summary Break-even and contribution margin analysis is useful as a frame of reference, as a vehicle for expressing overall managerial performance, and as a planning device via break-even techniques and what-if scenarios. The next points highlight the analytical usefulness of contribution margin analysis as a tool for profit planning: A change in either the selling price or the variable cost per unit alters CM or the CM ratio and thus the break-even point. As sales exceed the break-even point, a higher unit CM or CM ratio will result in greater profits than a small unit CM or CM ratio. The lower the break-even sales, the less risky the business and the safer the investment, other things being equal. A large margin of safety means lower operating risk since a large decrease in sales can occur before losses are experienced. Using the contribution income statement model and a spreadsheet program, such as Excel, a variety of what-if planning and decision scenarios can be evaluated. In a multiproduct firm, sales mix is often more important than overall market share...
eBook - ePub- Richard Kotas(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...5 Break-Even Analysis Introduction A simple break-even chart has already been illustrated. The purpose of the present chapter is to describe different kinds of break-even charts and show their applications to a variety of different situations. The term ‘break-even chart’ is rather unfortunate in that it focuses attention on one particular aspect of what is, in fact, a complex set of sales—cost—profit relationships. The principal aim of the break-even chart is not merely to ascertain the actual or potential break-even point, but also to show what net profit or loss will obtain over the whole range of activity, at what rate net profit will accrue when sales increase above the break-even point, the degree of profit stability of the business, etc. One of the main objectives of the break-even charts is to show, preferably in simple terms and without excessive detail, the total sales—cost—profit picture of the business. If it is to achieve this objective, it must be presented as an elegant, well thought-out document and create the right kind of visual impression. It is, consequently, better for the break-even chart to show only the essential data; other information may be given in appropriate schedules, profitability statements and similar documents. Basic break-even chart The basic break-even chart is the starting point for a more detailed consideration of Break-Even Analysis. Let us therefore take a simple example, construct a basic break-even chart and then look at some of its main features. Figure 5.1 Basic break-even chart It is assumed that a business has up to 10,000 customers per month and that its ASP is £10.00. Monthly fixed costs are £40,000 and variable costs are incurred at the rate of 40 per cent in relation to the volume of sales. The break-even chart for this operation would appear as shown in Figure 5.1. The information disclosed by the break-even chart is as follows. Break-even point This is reached when the number of covers is over 6,500...
eBook - ePubThe Business Plan Workbook
A Step-By-Step Guide to Creating and Developing a Successful Business
- Colin Barrow, Paul Barrow, Robert Brown(Authors)
- 2021(Publication Date)
- Kogan Page(Publisher)
...ASSIGNMENT 20 Break-Even Analysis Calculating your break-even point Let’s take an elementary example: a business plans to sell only one product and has only one fixed cost, the rent. In Figure 20.1 the vertical axis shows the value of sales and costs in thousands of pounds, and the horizontal axis the number of ‘units’ sold. The second horizontal line represents the fixed costs, those that do not change as volume increases. In this case it is the rent of £/$/€10,000. The angled line running from the top of the fixed costs line is the variable costs. In this example the business plans to buy in at £/$/€3 per unit, so every unit it sells adds that much to its fixed costs. Figure 20.1 Graph showing break-even point Figure 20.1 details The details of the line graph are as follows: The horizontal axis representing units ranges from 1000 to 7000 in increments of 1000. The vertical axis representing cost and revenues in thousands of currency units ranges from 5 to 25 in increments of 5. A horizontal line representing fixed cost passes through (0, 10) parallel to the horizontal axis. A diagonal line starting at (0, 10) and passing through (5000, 25) represents variable cost and another diagonal line starting at (0, 0) and passing through (5000, 25) represents total cost. The lines variable cost and total cost intersect at (5000, 25) and it is labelled break-even point. The sales revenue is above the break-even point in the total cost line. Only one element is needed to calculate the break-even point – the sales line. That is the line moving up at an angle from the bottom left-hand corner of the chart. The business plans to sell out at £/$/€5 per unit, so this line is calculated by multiplying the units sold by that price. The break-even point is the stage at which a business starts to make a profit...
eBook - ePubThe Strategy and Tactics of Pricing
A Guide to Growing More Profitably
- Thomas T. Nagle, Georg Müller(Authors)
- 2017(Publication Date)
- Routledge(Publisher)
...The price reduction will be profitable, however, when the volume effect (the area of box e) exceeds the price effect (the area of box c). That is, in order for the price change to be profitable, the gain in contribution resulting from the change in sales volume must be greater than the loss in contribution resulting from the change in price. The purpose of breakeven analysis is to calculate the minimum sales volume necessary for the volume effect (box e) to balance the price effect (box c). When sales exceed that amount, the price cut is profitable. EXHIBIT 9-2 Finding the Breakeven Sales Change So, how do we determine the breakeven sales change? We know that the lost contribution due to the price effect (box c) is $2,000, which means that the gain in contribution due to the volume effect (box e) must be at least $2,000 for the price cut to be profitable. Since each new unit sold following the price cut results in $4 in contribution ($9.50 – $5.50 = $4), Westside must sell at least an additional 500 units ($2,000 divided by $4 per unit) to make the price cut profitable. The minimum percent change in sales volume necessary to maintain at least the same contribution following a price change can be directly calculated by using the following simple formula (see Appendix 9B for derivation): - Δ P C M + Δ P In this equation, the price change and contribution margin may be stated in dollars, percentages, or decimals (as long as their use is consistent within the same formula). The result of this formula is a decimal ratio that, when multiplied by 100, is the percent change in unit sales necessary to maintain the same level of contribution after the price change. The minus sign in the numerator indicates a trade-off between price and volume: Price cuts increase the volume and price increases reduce the volume necessary to achieve any particular level of profitability...
