Break-Even Analysis TR TR TC VC FC Costs/Revenue

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Presentation transcript:

Break-Even Analysis TR TR TC VC FC Costs/Revenue The Break-even point occurs where total revenue equals total costs – the firm, in this example would have to sell Q1 to generate sufficient revenue to cover its costs. As output is generated, the firm will incur variable costs – these vary directly with the amount produced Costs/Revenue The lower the price, the less steep the total revenue curve. Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially. The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC TR TR TC Initially a firm will incur fixed costs, these do not depend on output or sales. VC FC Q1 Output/Sales

Break-Even Analysis TC VC FC Costs/Revenue Q1 Output/Sales TR (p = £3) If the firm chose to set price higher than £2 (say £3) the TR curve would be steeper – they would not have to sell as many units to break even TR (p = £2) VC FC Q2 Q1 Output/Sales

Break-Even Analysis TC VC FC Costs/Revenue Q1 Q3 Output/Sales TR (p = £1) Costs/Revenue If the firm chose to set prices lower (say £1) it would need to sell more units before covering its costs TR (p = £2) TC VC FC Q1 Q3 Output/Sales

Break-Even Analysis TC VC Profit Loss FC Costs/Revenue Q1 Output/Sales TR (p = £2) TC Costs/Revenue VC Profit Loss FC Q1 Output/Sales

Break-Even Analysis TC VC Margin of Safety FC Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be made TR (p = £3) TR (p = £2) TC A higher price would lower the break even point and the margin of safety would widen Costs/Revenue VC Assume current sales at Q2 Margin of Safety FC Q3 Q1 Q2 Output/Sales

Eurotunnel’s problem FC 1 FC Losses get bigger! TR VC Costs/Revenue High initial FC. Interest on debt rises each year – FC rise therefore FC 1 FC Losses get bigger! TR VC Output/Sales

Break-Even Analysis Remember: A higher price or lower price does not mean that break even will never be reached! The BE point depends on the number of sales needed to generate revenue to cover costs – the BE chart is NOT time related!

Break-Even Analysis Importance of Price Elasticity of Demand: Higher prices might mean fewer sales to break-even but those sales may take a longer time to achieve. Lower prices might encourage more customers but higher volume needed before sufficient revenue generated to break-even

Links of BE to pricing strategies and elasticity Break-Even Analysis Links of BE to pricing strategies and elasticity Penetration pricing – ‘high’ volume, ‘low’ price – more sales to break even Market Skimming – ‘high’ price ‘low’ volumes – fewer sales to break even Elasticity – what is likely to happen to sales when prices are increased or decreased?