3.3.2 Break-even charts and break-even analysis The Orangeman A grocer buys 15 dozen oranges at £0.99 a dozen. He finds 15 bad oranges in his stock. He sells the rest of the oranges in packs of three. What is the least amount that three oranges can sell for in order for the grocer to break even? £0.99 x 15 = £14.85. 15x12 = 180 oranges. 15 are bad so 165 oranges. 165/3=55 packs. £14.85/55 = £0.27 per pack. 3.3.2 Break-even charts and break-even analysis 3.3.2 Break-even charts and break-even analysis

Profit or Break-even? Making a profit will be the ultimate goal of most businesses but in the short term they may have to be satisfied with breaking even Making enough revenue to just cover all the costs No profit is being made but neither is a loss Break-even can be explained using the concept of contribution 3.3.2 Break-even charts and break-even analysis

Contribution and Contribution per unit 3.3.2 Break-even charts and break-even analysis Contribution and Contribution per unit What does the word contribution mean? when we contribute we give towards something In business each time a product is sold or service provided what does the money generated (the sales revenue) contribute towards? It has to firstly pay for its own variable costs and then contribute towards the fixed costs Until there are enough contributions to cover all the fixed costs the business can not start to make a profit

Contribution and Contribution per unit 3.3.2 Break-even charts and break-even analysis Contribution and Contribution per unit Contribution per unit is therefore the difference between selling price per unit and variable cost per unit i.e. how much is left to contribute Firstly to fixed costs Secondly to profit Contribution = Selling Price – Variable Cost If I sell T-shirts at £11.50, and each one costs me £4.00 to make, then from each item sold I have a contribution of £7.50 Total Contribution is the difference between total sales revenue and total variable costs If I sell 100 T-shirts total sales revenue is (100 x £11.50) £ 1150 and total variable cost is (100 x £4.00) £400 Therefore total contribution is £1150 - £400 = £750

Calculation of Break Even Output Break even is the point at which a business is not making a profit or a loss i.e. it is just breaking even Therefore at this point total costs must be the same as total revenue Each time an item is sold the difference between the selling price and the variable cost is contributed towards the fixed cost The business has to keep putting this excess (the contribution) towards fixed costs until they are all paid off 3.3.2 Break-even charts and break-even analysis

Calculation of Break Even Output Contribution per unit can therefore be used to calculate break even Contribution = Selling Price – Variable costs Fixed Cost / contribution = Break Even point The fixed costs to manufacture the T-shirts is £15000, premises, machines, irons, advertising Contribution = £11.50 - £4.00 = £7.50 Fixed Cost / contribution = break even point £15000 / £7.50 = 2000 The business would have to sell 2000 T-shirts to break even 3.3.2 Break-even charts and break-even analysis

Calculation of Break Even Output 3.3.2 Break-even charts and break-even analysis Calculation of Break Even Output Remember break even is where neither a profit or a loss is being made (TC = TR) No of T-shirts 1000 2000 3000 Fixed Costs 15000 Variable Costs 4000 8000 12000 Total Costs 19000 23000 27000 Total Revenue 11500 34500 Loss/Profit (15000) (7500) 7500

Question time 2 marks A business manufactures rocking horses. The table shows their predicted figures for the next year. How many rocking horses do they need to sell to breakeven? rocking horses £ Selling price per rocking horse 100 Variable cost per rocking horse 40 Fixed costs 12 000

3.3.2 Break-even charts and break-even analysis Break Even charts An alternative to calculating break even via contribution is to plot the lines on a break even chart This makes it easy to see where the break even point is i.e. where Total Costs = Total Revenue Break Even point should be read off the horizontal axis and therefore expressed as a number of units e.g. 2000 T-shirts

Break Even Charts – the build up 3.3.2 Break-even charts and break-even analysis Break Even Charts – the build up £ No of items Fixed costs stay the same and are therefore a straight horizontal line Variable costs change in relation to the number of items produced and therefore start at zero and slope upwards Total Costs are fixed costs plus variable costs and therefore start at the point of fixed costs and then slope upwards at the same gradient as variable costs. £ No of items £ No of items

Break Even Charts – the build up 3.3.2 Break-even charts and break-even analysis Break Even Charts – the build up Total Revenue increases with the amount of units sold and therefore starts at 0 and slopes upwards We now have to put our cost and revenue lines together to find the break even point. The important 2 lines being total costs (TC) and total revenue (TR). No of items £ £ No of items TR TC Break Even Point TC=TR Break Even Output read off the horizontal axis

Break Even Chart – T-shirts 3.3.2 Break-even charts and break-even analysis Break Even Chart – T-shirts What are the fixed costs at 2000 units? What are the variable costs at 2000 units? What are the total costs at 1000 units? What is the total revenue at 3000 units? What is the breakeven level of output?

Drawing a breakeven Chart A business manufactures computer desks. Fixed costs = £10 000 Variable cost per desk = £22 Selling price = £47 Draw a break even chart Step 1: Complete the table Step 2: plot the total cost and total revenue line on graph paper Step 3: label the breakeven point Desks 200 400 600 FC VC TC TR

Financial Planning – Break Even Prior to trading an entrepreneur may draw a break even chart or calculate break even to help see if their proposal is feasible i.e. how many units will they need to sell to break even This can then be compared to predicted sales estimated from market research If predicted sales is greater than break even point they may then consider by how much The difference between predicted sales, if higher than break even, and the break even point is known as the margin of safety 3.3.2 Break-even charts and break-even analysis

Using Break Even Charts 3.3.2 Break-even charts and break-even analysis Using Break Even Charts Break even charts can also be used to read off the loss or profit that would be experienced at different levels of sales £ No of items TR TC Q1 TC1 TR1 TC1>TR1 = Loss Q2 Q3 TR3 TC3 TR3 >TC3 = Profit TC2 = TR2 = BEP

Breakeven Chart At 1500 units will the business make a profit or a loss? At 2500 units will the business make a profit or a loss? If they sell 1000 units how much profit or loss is made? If they sell 3000 units how much profit or loss is made?

Using a breakeven chart As well as identifying costs, revenues, break even and profit or loss a breakeven chart can also be used to: Identify the margin of safety the difference between actual output and breakeven output Actual output – breakeven output = margin of safety

Breakeven Charts TR TC Costs and revenues £ Margin of safety FC Units TC Margin of safety FC Actual output Breakeven output

Changing Variables – price, costs and revenues 3.3.2 Break-even charts and break-even analysis Changing Variables – price, costs and revenues Established businesses as well as business start-ups must treat break even with a degree of caution It is based on the assumption that costs and revenues will be static In reality this is not true Businesses are often therefore advised to consider the variables that might change and possibly look at a number of scenarios Remember variables can change for the better or worse What variables might change? Fixed Costs Landlord puts rent up Bank changes interest rates Management want pay increase Variable Costs Raw materials change in price Minimum wage is increased Utility companies change price Selling Price New competition therefore forced to lower price Positive word of mouth puts demand up

Strengths and Weaknesses of Break Even Allows entrepreneurs to calculate the minimum number of sales needed before starting to make a profit Can foresee the level of profit or loss at different levels Can predict the outcome of changing variables Provides a target An integral part of a business plan when seeking to secure finance Aids decision making Weaknesses Is based on predicted costs and revenues Even fixed costs can vary in reality Ignores changes in variable costs or selling price as items are bought or sold in larger quantities Only indicates the number of sales needed does not ensure actual sales will materialise A new entrepreneur may lack experience in predicting costs and hence draw a break even on inaccurate data 3.3.2 Break-even charts and break-even analysis

Activity – Break Even Analysis Trevor is considering setting up a small business selling toffee apples and other confectionery products at fairs and car boot sales in his local area As part of his market research he agrees to have a small stall at his daughter’s primary school fair selling toffee apples The stall will cost him £25 for the day Apples cost £0.20 each and he estimates other costs including toffee and sticks to be £0.10 per apple Trevor decides to order 100 toffee apples for the day. What is Trevor’s break even point for the school fair? How useful will this information be in predicting the break even point for his business venture? What factors might affect Trevor’s ability to break even a) at the fair b) in the first year of trading? 3.3.2 Break-even charts and break-even analysis

Break even Statement True or false Explain your answer Fixed cost is a horizontal straight line Total cost line starts at zero Breakeven point is where total revenue is equal to variable costs If TC is less than TR a business has passed breakeven point Margin of safety is to the right of breakeven If fixed costs go up and everything else stays the same breakeven point will rise