Break-even Revenue Level AS Economics and Business Unit 1

Lesson Objectives To be able to identify the contribution from a potential range of products and services To be able to identify break-even revenue To assess if the break-even revenue level is achievable To be able to identify a desired margin of safety To be able to answer some past paper questions based on the topic

Starter If you had 100 Christmas trees to sell and each one cost you £2.00 to buy, you decide to sell them at £5. Which tree will be the first one that is pure profit when sold? 100 trees x £2 each = initial investment of £200 You start selling at £5 each and have to sell 40 trees to recoup your investment Your 41st tree will be the tree that makes a profit

Definition of Break-even The point at which revenue equals cost so your business is making neither a profit nor a loss Note: break-even is expressed as an amount of output NOT a money value

Get yer calculators out!

Break-even calculations First we need to know the contribution that selling the item makes towards the profit. We calculate contribution; C= SP – VC Where SP is selling price per item and VC is variable cost per item

Contribution calculation practise You sell cricket bats for £25, they cost £14 to make You sell sea shells down on the sea shore for £10 a bag and they cost £3 to put together You sell red and yellow lorries for £5 each in your shop and they cost £1 to import from China 1) C= 25-14 C=£11 2) C = 10-3 C=£7 3) C = 5-1 C= £4

Full break-even formula Break even point can be found when: FC ____ C Where FC is fixed costs of a business (rent etc) Where C is contribution (SP-VC)

Break-even calculation practise Lucy sets up a business to print T-shirts. The fixed costs of premises and the T-shirt printers are £3000. The variable costs per T-shirt (the T-shirt, ink, wages) are £5. Each printed T-shirt sells for £25. How many t-shirts does Lucy need to sell to break-even? Price Per Unit – Variable Cost Per Unit = Contribution (Towards Fixed Costs). £25 - £5 = £20 (Contribution Towards Fixed Costs) Fixed Costs / Contribution = Break-even Point. £3000 / 20 = 150 150 T-shirts will need to be sold in order to break-even and cover all her costs.

Margin of safety This is the difference between the break-even point and the current level of output. If Buddy produces 100 cakes in his bakery and his current break-even level is 25 then the margin of safety would be: Production – Breakeven = Margin of safety 100 – 25 = 75 cakes

Glossary – quick test Revenue (turnover) Break-even Variable costs Fixed costs Contribution Margin of safety Overheads Direct costs Indirect costs (answers in notes section of slide show – press escape button on keyboard to view) Revenue (turnover)- income received into the business over a time period Break-even – the point at which the level of output is where fixed and variable costs are being met by revenue Variable costs – vary with level of output in the short term Fixed costs – don’t vary with output in the short term Contribution – the contribution that a product makes towards paying for the fixed costs of the business Margin of safety – surplus of planned revenue over planned costs to allow for unforeseen developments Overheads – indirect costs that are not linked to specific products Direct costs – costs linked to a specific product Indirect costs – costs not linked to a specific product

Break-even diagram Loss Total Revenue Total Costs Profit Quantity Total Costs/ Revenue £ Quantity Total Revenue Total Costs Loss Profit Breakeven Point 50 Units 100 Units 150 Units

Break-even diagram with margin of safety Total Costs/ Revenue £ Quantity Total Revenue Total Costs Loss Profit Breakeven Point 50 Units 100 Units 150 Units Margin of Safety 150-100= 50

Sample question 1

Answer question 1 Answer 250 B Explain your answer (show your workings) - Break-even is fixed costs/contribution OR breakeven occurs when total revenue equals total costs (1 mark) - Which is 12,500 / 50 (2 marks; 1 mark per applied part of equation) Any acceptable answer which shows selective knowledge/application and/or development NB Up to 2 additional marks for part (b) if part (a) is incorrect.

Sample question 2 In his attempts to persuade the Dragons to finance his business venture, it might have been useful for Levi to have prepared break-even analysis for Reggae Reggae Sauce. Assess the likely value of break-even analysis to Levi Roots. [8]

Answer question 2

Sample question 3 Adonis Dascalakis, the Head Chef at Aroma Italia Pizzeria, has calculated that he needs to prepare 60 meals a day at an average price of £12 per customer in order to break even. Fixed costs work out at approximately £120 per day. Which of the following is the average variable cost per meal for Aroma Italia Pizzeria at the break-even level of output? A £10 B £4 C £8 D £2 [4]

Answer question 3 Which of the following is the average variable cost per meal for Aroma Italia at the break-even level of output? Answer – £10 (A) 1 Explain your answer (show all your workings) - Defines average variable cost or break-even OR Uses a correct formula, e.g. FC/Output = contribution OR (total revenue – FC)/output = variable cost OR break-even = FC/contribution OR selling price – contribution = average variable cost (1 mark) (Knowledge must be shown for 1 mark) - Applies data, i.e. 120/60 = 2 (1 mark application), then 12-2/? = 10 (1 mark application) - Or 720-120=600/60=10 (2 marks) NB DO NOT accept 120/12=10 (not strictly applied)

Sample question 4 Sandwell Sheds Ltd has fixed costs of £1000 per month and it sells sheds at an average price of £200. Average variable costs per shed are £160. What is Sandwell Sheds Ltd’s break-even level of output per month? A 25 sheds B 50 sheds C 250 sheds D 800 sheds [4]

Answer question 4 Answer is A 25 sheds - Definition of break even/formula, e.g. FC/Contribution (1 mark) - Insert partial data, e.g. FC = 1000/? (1 mark) - Complete data in the formula, i.e. 1000/40 (1 mark) Any acceptable answer which shows selective knowledge/application and/or development NB up to 2 marks out of 3 may be gained for part (b) if part (a) is incorrect.

Sample question 5

Answer question 5 Correct answer was D = 400 - Definition of margin of safety (1) - Defines break even (1) - At 900 units the business is operating at 400 units above break even (500) (1) - Therefore the Margin of Safety is 400; 900-500 (1) Any acceptable answer which shows selective knowledge/application and/or development NB up to 2 marks out of 3 may be gained for part (b) if part (a) is incorrect.

Revision Video