Financial planning: break-even

Syllabus Candidates should be able to: define contribution and contribution per unit (selling price – variable cost per unit) calculate break-even and construct charts showing break-even point (when total fixed cost + total variable cost = total revenue) use contribution to calculate the break-even point analyse the margin of safety interpret break-even charts evaluate the limitations of break-even analysis

Break-even and break-even charts Break-even occurs when a firm is making neither a profit nor a loss. It is generating enough revenue to cover costs, but no more. It occurs when total _______ equals total ______ Break-even charts show variable costs, fixed costs, total costs and revenue. It is usually easier to draw up a table first.

Example Draw up a table and use it to create a break-even graph. Find the break-even point. selling price = £10 variable cost per unit = £5 fixed costs = £1000 per month maximum output = 250 units per month

Break-even table Number of units Revenue (£10 each) Fixed costs Variable costs (£5 each) Total costs Profit

Break-even formula Break-even can also be found by using a formula: Break-even = fixed costs selling price – variable costs per unit So what is the break-even point in the previous example using the formula? E.g. break-even =

Break-even There are three ways of finding the break even:

Margin of safety The margin of safety is the difference between the current level of sales and the break-even output. On the break-even chart it is the _______________ distance from current sales to the break-even point. It can be calculated as Margin of safety = current sales – break even

Advantages of break-even analysis

Disadvantages of break-even analysis

Common errors with break-even What is wrong with the following statements? ‘Calculating the break-even point will ensure that the firm covers its costs’

Common errors with break-even What is wrong with the following statements? ‘As firm Y is 50 units short of break-even output, it should cut the selling price. This will mean that sales will go up by 50 units and they will break-even’

Questions 1. Calculate the number of units that would need to be sold to break-even if a firm sells its products for £5 per unit, has variable costs of £2 per unit and fixed costs of £ If the firm is currently selling 2500 units, what is its margin of safety?

Contribution Contribution is the amount of money that is left over after deducting variable costs from revenue. The formula is: contribution = selling price – variable cost per unit

Contribution example If a firm makes shirts that cost £5 per unit in materials and labour, and can sell them for £12, what is the contribution? If the firm’s fixed overhead costs are £700 per week then how many must it sell to cover these costs? How many must it sell to generate profit?

Total contribution total contribution = contribution per unit X units sold Or total contribution = total revenue – total variable costs In the previous example, weekly sales of 300 shirts would generate: total contribution =

Using contribution

Contribution EXTENSION QUESTION 1. What would happen to total contribution if the following single changes took place: suppliers charge more for materials => contribution _________ the firm sells more products => contribution _________ selling price is increased due to increased demand => contribution _________

Contribution question EXTENSION QUESTION 2. A firm has sales of 200 units a week at a selling price of £30 each. Its variable costs per unit are £18 and fixed costs are £2000. Calculate its current total contribution per week

Revision activity Create a revision resource (a poster, a table etc.), it should include definitions or formula for: Break even Contribution per unit Fixed cost Margin of safety Total contribution