1. Financial Decision Making 3 Break-even analysis

2. Financial Decision Making 3 Break-even analysis
Cost behaviour – recap
CVP analysis
Break-even charts and calculations
Contribution
Other measures
Using of break-even analysis
Relevant ranges of output
Reading: Drury chapter 3
Financial Decision Making 3 Break-even analysis

3. Financial Decision Making 3 Break-even analysis
Cost behaviour – recap
The way costs change with the level of activity
Variable costs
Fixed costs
Stepped fixed costs
Semi-variable costs
Can be split into fixed and variable elements
Financial Decision Making 3 Break-even analysis

4. Cost-volume-profit analysis (CVP)
Based on short-term relationship between costs, volume and sales revenue
Provides information for decision making
Useful for short-term decisions
Key example – break-even analysis
Identify level of output at which business will ‘break-even’
Financial Decision Making 3 Break-even analysis

5. Financial Decision Making 3 Break-even analysis
Break-even chart
Sales revenue
Revenue / costs (£)
Break-even point
PROFIT
Total costs
Variable costs
LOSS
Fixed costs
Volume of activity (units of output)
Financial Decision Making 3 Break-even analysis

6. Calculating the break-even point
Profit = sales revenue – total cost
Profit = sales revenue – (fixed + variable costs)
Profit = quantity × price – fixed costs – (quantity × variable cost per unit)
Profit = quantity × (price –variable cost per unit) – fixed costs
At break even point, profit = 0
Then quantity × (price –variable cost per unit) = fixed costs
or quantity = fixed costs
Price – variable cost per unit
Financial Decision Making 3 Break-even analysis

7. Financial Decision Making 3 Break-even analysis
Contribution
Sales price – variable cost per unit is contribution
Contribution is the surplus remaining after deducting variable costs from the sales price
Which is the amount left to put towards paying for fixed costs and to provide for profit
So break-even quantity is given by:
Number of units = fixed costs
contribution per unit
Financial Decision Making 3 Break-even analysis

8. Financial Decision Making 3 Break-even analysis
Other measures
Margin of safety
Difference between planned output and break-even quantity
May be expressed as a percentage
Contribution / sales ratio
Proportion of each £1 sale available to cover fixed costs and provide profit
To make target profit:
Number of units = fixed costs + target profit
contribution per unit
Financial Decision Making 3 Break-even analysis

9. Examples of the use of break-even analysis
Why do businesses such as airlines pay attention to the break-even point?
What applications can you suggest?
CIMA 2009 survey of companies worldwide:
Around 40% of all companies use break-even analysis
50% of very large companies use it
Financial Decision Making 3 Break-even analysis

10. Assumptions in break-even analysis
All other variables remain constant
Single product or constant sales mix
see Drury for multiple product analysis
Linear relationship between volume, cost and revenue
Costs can be accurately divided into fixed and variable elements
Applies to short-term horizon
Applies to relevant range
Financial Decision Making 3 Break-even analysis

11. Relevant range of output
Sales revenue
Revenue / costs (£)
Break-even points
Total costs
Fixed costs
Relevant ranges
As far as next step change
Volume of activity (units of output)
Financial Decision Making 3 Break-even analysis