Business Finance Costs Break-Even Analysis

Revenue and Costs “Revenue” is income earned by a firm when they sell either the goods it makes or the services it offers. Money received from customers is called sales, sales revenue or turnover. “Costs” are all the types of expenditure that a firm has when it first starts up and when it is operating on a day-to-day basis.

Revision … Costs that do not vary with output are called: FIXED COSTS Costs that do vary with output are called: VARIABLE COSTS The money a business receives from its customers is called: REVENUE (OR SALES REVENUE) To calculate profit, you do the sum: Total revenue minus ? TOTAL COSTS The point at which total revenue equals total costs is called: THE BREAK-EVEN POINT

Fixed and Variable Costs Fixed Costs Costs that DO NOT change when the level of output changes. Fixed costs stay the same whether a firm is producing 100 units or 1,000 units. Fixed costs still have to be paid even if nothing is produced. eg: rent, rates, insurance, wages, leasing equipment, electricity bill Variable Costs Costs that DO change when the level of output changes. The more that is produced, the more of these items have to be purchased. eg stock and raw materials Would the item be paid for if nothing was produced? If yes, it is a FIXED COST

Fixed or Variable Cost? Loan repayment to a bank Fixed Cost Purchase of CDs and USB sticks Variable Cost Insurance for the web design premises Fixed Cost Wages Fixed Cost Purchase of paper to print invoices to customers Variable Cost

Constructing a Break-Even Chart £ Output Sales revenue Total Costs Fixed Costs Break-even Point Margin of Safety Profit if we hit our sales target

Number of Units Fixed Costs Variable Costs Total Costs Sales Revenue Break-even Table: based on a price of £200 Fixed costs are £800, the variable cost per unit is £

Break-Even Chart: Price £200 £ Revenue Number of units Sales revenue Total Costs Fixed Costs Break-even Point Profit if we sell 12 units = £ Loss if we only sell 4 units = £400 Break even Point = 8 units

Number of Units Fixed Costs Variable Costs Total Costs Sales Revenue Break-even Table: based on a price of £100 Fixed costs are £200, the variable cost per unit is £

Break-Even Chart: Price £50 £ Revenue Number of units Sales revenue Total Costs Fixed Costs Break-even Point Profit if we sell 6 units = £ Loss if we only sell 2 units = £100

Calculating the break-even point without a graph To calculate how many products we need to sell in order to break even and cover our costs. Formula: Fixed Costs Contribution (Price – Variable cost)

Use the break-even formula to work out the break-even point for questions 1-5 below Formula: Fixed Costs Contribution (Price – Variable cost) 1.Fixed cost = £20,000, price = £4,000, variable cost = £2,000 2.Fixed cost = £10,000, price = £4,000, variable cost = £2,000 3.Fixed cost = £26,000, price = £5,000, variable cost = £3,000 4.Fixed cost = £50,000, price = £20,000, variable cost = £10,000 5.Fixed cost = £1,000, price = £800, variable cost = £300 20,000 / 2,000 = 10 26,000 / 2,000 = 13 10,000 / 2,000 = 5 50,000 / 10,000 = 5 1,000 / 500 = 2

Using the Break Even Formula Fixed Costs Price – Variable Cost 1.Fixed cost = £600, price = £400, variable cost = £100 2.Fixed cost = £10, price = £3, variable cost = £1 3.Fixed cost = £260, price = £50, variable cost = £30 4.Fixed cost = £50,000, price = £4,000, variable cost = £2,000 5.Fixed cost = £1,000, price = £400, variable cost = £ / 300 = 2 50,000 / 2,000 = / 2 = / 20 = 13 1,000 / 200 = 5

Finance Terms Fixed Cost Total Costs Sales Revenue Variable Cost Break Even Point

Number of Units Fixed Costs Variable Costs Total Costs Total Revenue Break-even Table: based on a price of £100 Fixed costs are £500, the variable cost per unit is £

Break-Even Chart: Price £50 £ Revenue Number of units Sales revenue Total Costs Fixed Costs Break-even Point Profit if we sell 15 units = £ Loss if we only sell 5 units = £250

Using the Break Even Formula Fixed Costs Price – Variable Cost 1.Fixed cost = £600, price = £400, variable cost = £100 2.Fixed cost = £10, price = £3, variable cost = £1 3.Fixed cost = £260, price = £50, variable cost = £30 4.Fixed cost = £50,000, price = £4,000, variable cost = £2,000 5.Fixed cost = £1,000, price = £400, variable cost = £ / 300 = 2 50,000 / 2,000 = / 2 = / 20 = 13 1,000 / 200 = 5

Effect on the BEP if costs or revenue change If fixed costs or variable costs increase, the BEP will increase – the firm will have to sell more products to cover their costs. If the selling price is increased, the BEP will decrease – the total revenue will increase so the firm can sell less products to cover their costs.

How a firm can improve the BEP 1.Increase the price of the product. The firm will receive more revenue and will have to sell less products in order to break even. 2.Decrease the fixed or variable costs. The total costs will then be lower so the firm will have to sell less products in order to break even.

Break Even: Exam Example A café has fixed costs of £5,000 per month. The variable costs are £5 per item and the selling price is £10. 1.What is the BEP?3 marks £5,000 / £5=1,000 2.If the fixed costs rose to £6,000, what would be the effect on the break even point for the firm?3 marks BEP would be higher – have to sell more products in order to break even BEP would be 1,200 (£6,000 / £5 = 1,200) 3.If the fixed costs stayed at £5,000 but the variable cost rose to £6 per item, what would be the effect for the firm?3 marks BEP would be higher – have to sell more products in order to break even BEP would be 1,250 (£5,000 / £4 = 1250) 4.If the fixed and variable costs stayed the same and the price rose to £15 per item, what would be the effect on the firm?3 marks BEP would be lower – have to sell less in order to break even BEP would be 500 (£5,000 / 10 = 500)

Examination Question WDP Ltd has fixed costs of £2,000 per month. They sell professional websites for £1,000 and their variable cost per website is £ How many websites must they sell each month to break even?Show your calculations 2.If the fixed costs rose to £2,500 per month, what would be the effect on the break even point? Explain in words and show your calculations 3.Presuming that the fixed costs remained at £2,000 and the variable costs remained at £500, explain how WDP Ltd could lower their break even point. Explain in words and give an example

Pass the Buck: I will give you a topic. In turn, each member of your team must write down TWO things about the topic. Fold the paper over and pass the paper to the next person in your team – they then write down TWO things. You get a point for every different issue you write down.