1. IB Business Management
UNIT: 3.3 – Break-even Analysis
Understand/practice break-even analysis & margin of safety

2. Fixed or Variable? Rent Wages Salaries Materials Insurance Commission
Utilities

3. Breaking Even
Business can be in one of the following financial situations:
Loss: costs exceeds revenue
Break-Even: costs equal revenue
Profit: revenue exceeds costs

4. Breaking Even
Break-even point exists where a business makes neither profit nor loss
This occurs at the level of output where total costs equal total revenue
Typically a goal of new firms

5. Contribution What is the purpose of calculating contribution?
* Any product w/ a positive contribution will help pay some of the FC of the company.
Contribution per unit = P – AVC
This is just calculating margin

6. Ways to improve profit Increase Sales Revenue How do you do this?
Decrease Variable Costs
Decrease Fixed Costs
Marketing (Promotions), New sales incentives, product life cycle extension strategies,
Talk to suppliers, try to get supply costs down by getting different suppliers
Better financial control, maybe looking at cost centers

7. Meaning of Break-Even Point
Total Costs = Total Revenue when output reaches the break-even point
Any sales above the break-even quantity will generate a profit
Sales below the break-even level will yield a loss

8. Break-even Analysis
A business can only survive in the long run if revenue > costs
New firms especially want to determine the level of sales needed to generate a profit

9. Break-Even Analysis
Two purposes for conducting a break-even analysis, which helps determine:
If its financially worthwhile to produce a particular good or service (such as introducing a new product)
Amount of profit that business is likely to earn if things go according to plan

10. Break-Even Analysis Example
Jeans retailer has fixed costs of $3,500 per month
Each pair of jeans sells for $30
$10 in variable costs per pair of jeans
What is the break-even point?

11. Calculating Break-Even Point
Method 1
Identify where total costs equal total revenue on a break-even chart
The break-even point is the position where the total cost line intersects the total revenue line (TC=TR)

12. Calculating Break-Even Point
Method 2
Using the TC = TR rule:
TFC + TVC = Price x Quantity
(Q) = 30Q
3500 = 20Q
175 = Q (pairs of jeans)

13. Calculating Break-Even Point
Method 3
Unit contribution is the difference between a product’s price and variable cost
Contribution = Price – VC
Break-Even Point = TFC / Unit Contribution
$3500
$30-10
= 175 pairs

14. Break-Even Example
Use the unit contribution method to calculate the break-even quantity for a firm that has the following financials:
TFC = $200,000
AVC = $5
Price = $30
P - AVC = unit contribution
Break-even = fixed costs
unit contribution

15. Calculate this BEQ
A high end kite maker has fixed costs of 25,500. She has a Variable Cost of $50 She is selling the kites for $75 Calculate the break-even quantity? Calculate the value of the total revenue at the break-even quantity. Calculate the value of total costs at the break-even quantity.

16. Margin of Safety
Measures difference between firm’s current sales quantity & break-even point
Positive margin means that firm is making a profit
Always shown in units, not dollars!
Safety margin = level of demand – breakeven qty.
Already have orders.

17. Margin of Safety Example
Demand for jeans is 280 pairs per month
Break-even point is 175 pairs per month
Safety margin is 105 units ( = 105)
This means the business can sell 105 fewer pairs of jeans before losing money.

18. MOS as a percentage of BEQ
It is easier to compare the 2 numbers if it is written as a percentage.
(BEQ/Level of demand) x 100
(105 ÷ 175) x 100 = 60%

19. Constructing a Break-even Chart
Rules to follow when constructing BE chart:
Draw/label TFC line
Draw/label TC line. Q = 0; TC start at ???
Draw/label TR line. Q = 0; TR starts at ???
X-axis is labeled as “Output” or units
Y-axis is labeled as “Costs, Revenues” $