Break Even

Aims for today To understand what break even is and how it can be used to assist businesses in their planning

Starter task: Formula recap

Match the formulas Contribution Break Even in units Margin of safety Total Revenue Profit or loss? Selling price x Quantity Actual production level – break even output Total revenue – Total costs Fixed costs/contribution Selling Price – Variable costs

What does break even mean? Break even is where a firms TOTAL REVENUE is the same as its TOTAL COSTS (In other words, money coming in = money going out). At the break even point, a firm is neither making a PROFIT nor A LOSS Q: Why would it be useful for a toy manufacturing business to calculate its break even point? To understand the role & purpose of break even analysis

Break even Break even analysis is useful as a business can work out what volume of sales it needs to achieve to cover its costs. The key to break even is to work out the contribution made from the sale of each unit. The amount of money from each unit sold contributes to pay for the fixed and indirect costs of the business.

To understand the role & purpose of break even analysis Break even formula Contribution To understand the role & purpose of break even analysis

Contribution = selling price less variable costs per unit (SP - VC) Contribution formula Contribution = selling price less variable costs per unit (SP - VC) Cans of coke = £1 - 0.25 = 0.75 contribution Fixed costs are £6,000 BE = FC / Contribution 6,000 / 0.75 = 8000 Cans need to be sold to break even

A CD factory has the following costs: Fixed cost: £10,000 Variable cost: £2 Selling price: £7 Q: Calculate the break even point in units and the break point in revenue. ANSWER: In units £10,000 / (£7-2) = 2000 units In revenue: £2,000 x £7 = £14,00

Break even point in units = Fixed costs / contribution £10,000 / (£7-2) = 2000 units

Break even point in revenue Quantity at break even x Selling price £2,000 x £7 = £14,00

Calculating the break even point Step 1. Identify fixed & variable costs – add them together to get the TOTAL costs Step 2. Calculate the TOTAL REVENUE To understand the role & purpose of break even analysis

Task 1: Calculating break even To understand the role & purpose of break even analysis

To understand the role & purpose of break even analysis OUTPUT FC VC TC TR (SP=£4) Profit 2000 -2000 200 400 2400 800 -1600 2800 1600 -1200 600 1200 3200 -800 3600 -400 1000 4000 4400 4800 1400 5600 5200 6400 1800 7200 6000 8000 To understand the role & purpose of break even analysis

Task 2: Draw the break even chart using your data Label the vertical axis “sales and costs in pounds”. Label the horizontal axis “sales/production (units)”. Draw on the BE point Draw a horizontal line for total fixed costs. Starting at the Total costs point, draw the total cost line going through the break even point. Starting at zero, draw the total revenue line through the break even. Where the sales revenue crosses the total costs line is the break even point. Read off the units of sales to give the break even level of sales. The gap between the total costs line and sales revenue line after the break even point represents the level of profit. To understand the role & purpose of break even analysis

To understand the role & purpose of break even analysis The break even chart To understand the role & purpose of break even analysis

Margin of safety formula The difference between the planned number of units or actual sales and the number of units of sales at break even point. Cans of coke: They can make: 10,000 cans potentially – 8,000 actual units at break even = 2,000 Margin of safety

Task 3: Draw the margin of safety To understand the role & purpose of break even analysis

Extension task: Break even worksheet Complete worksheets: #3 Break Even Analysis #4 Break even charts To understand the role & purpose of break even analysis

Why must businesses understand its break even point? …because the contribution from every unit sold above the break-even point adds to profit. The break-even point provides a focus for the business; It works out whether the forecast sales will be enough to produce a profit and; Whether or not further investment in the product is worthwhile.

Limitations of break-even charts? Assumes all stock is sold Does not take into account possible changes in costs over the time period Does not allow for changes in the selling price. Analysis is only as good as the quality of information. Does not allow for changes in market conditions in the time period – e.g. entry of new competitor.

Task 4 Hot Dogs Helen & Joe operate a hot dog stand in the town centre. The stand costs £200 per week to hire. Each hot dog needs one bread roll at 20p, one sausage at 25p and sauces at 5p. The selling price of each hot dog is £1

Complete the table At what quantity do total costs = total revenue Complete the table At what quantity do total costs = total revenue? (Break even) What profit is made when they sell 600 hot dogs? QUANTITY FIXED COSTS VARIABLE COSTS TOTAL COSTS TOTAL REVENUE PROFIT OR LOSS? 100 150 200 250 300 350 400 450 500 550 600 650

Complete the table At what quantity do total costs = total revenue Complete the table At what quantity do total costs = total revenue? (Break even) What profit is made when they sell 600 hot dogs? QUANTITY FIXED COSTS VARIABLE COSTS TOTAL COSTS TOTAL REVENUE PROFIT OR LOSS? 100 150 200 250 300 350 400 450 500 550 600 650

Complete the table At what quantity do total costs = total revenue Complete the table At what quantity do total costs = total revenue? (Break even) What profit is made when they sell 600 hot dogs? QUANTITY FIXED COSTS VARIABLE COSTS TOTAL COSTS TOTAL REVENUE PROFIT OR LOSS? 100 200 50 250 -150 150 75 275 -125 300 -100 125 325 -75 350 -50 175 375 -25 400 450 225 425 25 500 550 475 600 650 525

Task 5 Draw a Break Even chart for the Hot Dog business - Ensure your chart is FULLY and CLEARLY labelled Draw on the margin of safety (1) Explain how the Break even analysis will help Helen and Joe (4) Discuss what strategies Helen and Joe could use to enable them to reach their break even point quicker (6) Evaluate which of these strategies would be best for the business (6)

Plenary 1: Break even drag & drop http://www.businessstudiesonline.co.uk/AppliedGcseBusiness/Activities/Unit3/BreakEven/BreakEvenTermsDragDrop/frame.htm To understand the role & purpose of break even analysis

Break even drag & drop solution To understand the role & purpose of break even analysis

Plenary 2: Break even piggy bank http://www.quia.com/cz/5773.html?AP_rand=331777296 To understand the role & purpose of break even analysis

Plenary 3: Formula Recap

Selling Price – Variable costs Contribution Selling Price – Variable costs To understand the role & purpose of break even analysis

Break Even in units Fixed costs/contribution To understand the role & purpose of break even analysis

Break Even Revenue Break Even Quantity x Selling price To understand the role & purpose of break even analysis

Margin of safety Actual production level – break even output To understand the role & purpose of break even analysis

Total Revenue Selling price x Quantity To understand the role & purpose of break even analysis

Total Revenue Selling price x Quantity To understand the role & purpose of break even analysis

Total revenue – Total costs Profit or loss? Total revenue – Total costs To understand the role & purpose of break even analysis