2F Break Even Analysis

What is it? It allows us to estimate how many items need to be sold in order to cover all costs It calculates what needs to be sold (necessary future sales) before profits can be earned It is based on estimating total costs and total revenue (takings)

Fixed Costs and Variable Costs Total Costs are made up of: Fixed Costs and Variable Costs

Fixed Costs - are costs which do not rise as sales rise For example a firm will not be charged more rent just because it increases its sales to customers so rent is a fixed cost other fixed costs are insurance, heating and lighting, bank interest on a loan

Fixed Costs shown as a graph fixed costs behave like this: Costs £ 500 400 300 200 100 0 50 100 150 200 250 300 350 Fixed Costs Units Sold each week

Variable Costs - are costs which vary as sales vary - they rise when sales rise and fall when sales fall they are directly linked to sales – they vary with sales so the cost of packaging is a variable cost another variable cost is the cost of giving a free gift with every item sold

Variable Costs shown as a graph variable costs behave like this: Costs 500 400 300 200 100 0 50 100 150 200 250 300 350 Units Sold each week

Costs £ Total Cost 600 Variable Cost 500 400 300 Fixed Cost 200 100 0 50 100 150 200 250 300 350 Units Sold each week

Sales Revenue this is the money taken when items are sold Total sales revenue is the number of units sold times the unit price If you sell 100 items a week at the price of £2 each then Sales Revenue is 100 x £2 = £200

Sales Revenue shown as a graph Sales Revenue behaves like this: Costs £ 600 Sales Revenue 500 400 300 200 100 0 50 100 150 200 250 300 350 Units Sold each week at £2 each

How do we find Break Even Point? Find the sales level where Total Cost and Sales Revenue meet Costs Sales Revenue £ 600 Total Cost 500 400 300 200 100 0 50 100 150 200 250 300 350 400 Costs are covered when 300 units per week as sold

A Formula for Break Even Fixed Costs Selling Price – Variable Cost (per item) (per item)

Key Words Fixed Costs - costs that remain the same even as sales rise Variable Costs – costs that rise as sales rise Total Costs – Fixed Costs plus Variable Costs Break-Even Point – the level of sales at which all costs are just met Break-Even Chart – graph that plots sales revenue and total costs and indicates break-even point Return – selling price minus variable cost also known as contribution (how much of the selling price which contributes to meeting fixed costs and then profit)