1. 4.2.3 Explain, Interpret and Use a Break-Even Chart
IGCSE Business Studies
4.2.3 Explain, Interpret and Use a Break-Even Chart

2. LEARNING OBJECTIVES To understand the concept of break even
To be able to construct, complete or amend a break-even chart
To be able to interpret a given chart and use it to analyse a situation
To be able to use a chart to make decisions
To understand the limitations of break-even charts

3. Starter – 5 mins Match the definition with the correct key terms
Label the lines on break even chart

4. Break-even 1. The graphical method
Tutor2u Break-even simulator
Use Tutor2u’s excellent Break-even Simulator on an interactive whiteboard to demonstrate the relationships between the various variables.
Break-even
1. The graphical
method

5. Costs and revenue task Bobby Stokes makes Glory™
Materials cost £2 and overheads are £1 million per month
His factory has a capacity of 200,000 Glories™
Bobby sells Glory™ to wholesalers for £10
Construct a data table of his costs and revenue (FC, VC, TC, TR) for ranges of output from 0 to 200,000 units
use increments of 20,000 units
From the data table, sketch a graph
with the y-axis scale ranging from £0 to £2,000,000
Identify the break-even point

6. Costs and revenue Output ('000) Fixed Cost ('000) Variable Cost ('000)
Total Cost ('000)
Total Revenue ('000) 20 40 60 80
100
120
140
160
180
200

7. Costs and revenue Output ('000) Fixed Cost ('000) Variable Cost ('000)
Total Cost ('000)
Total Revenue ('000)
1,000
 1,000  0 20 40
1,040
200 80
1,080
400 60
120
1,120
600
160
1,160
800
100
1,200
240
1,240
 1,200
140
280
1,280
1,400
320
1,320
1,600
180
360
1,360
1,800
2,000

8. Costs and revenue

9. Costs and revenue
Break-even point

10. Costs and revenue quick questions
Looking at your graph, how many Glories™ must Bobby produce if he is to break-even?
Define break-even in a single sentence
Reading from your graph, estimate the amount of profit/loss Bobby will make if he makes and sells:
60,000 Glories™
160,000 Glories™

11. Costs and revenue
Break-even point

12. Break-even Simulator (Tutor2u) task
Management might be reluctant to increase price because:
Increasing price might make the product more expensive than the competition
Market research might indicate that customers are unwilling to pay more
(in both cases, sales might fall heavily with the price increase)
The target profit could be achieved by:
Reducing variable costs (e.g. finding cheaper raw materials)
Cutting fixed costs (e.g. moving to a cheaper factory, reducing the number of office staff etc.)
Selling price should increase to £52
Margin of safety = 1,538 units. This is the difference between the break-even output and the expected output
Use the simulator to find the total contribution and net profit when:
Selling price = £50
Variable cost per unit = £26
Fixed costs = £350,000
(Expected output = 15,000 units)
By how much should selling price change if the firm wishes to aim for a net profit of £40,000?
What is the margin of safety at that output? What does this mean?
Management is reluctant to raise price.
Why do you think this might be?
How else could they try to achieve this target profit?
Total contribution = £360,000
Net profit = £10,000

13. Break-even analysis
2. Calculation
method

14. Calculating break-even
Contribution: Defined as ‘the contribution that selling a single unit makes towards fixed costs and profit’
Contribution = Price per unit – Variable Cost per unit
Break-even point =
Fixed costs
contribution
learn these equations!

15. Calculating break-even Example
You manufacture CDs. You sell them to retailers for £8. The variable cost per CD is £1 and fixed costs are £70,000
What is the break-even output?

16. Calculating break-even Example
A fast-food restaurant sells meals for £6 each
The variable costs of preparing and serving each meal are £2
The monthly fixed costs of the restaurant amount to £3,600
How many meals must be sold each month to break even?
If the restaurant sold 1,500 meals in April, what were the margin of safety and profit in that month?

17. Answer (1) Contribution = Price – VC = £6 – £2 = £4
Break-even point = 3,600 ÷ £4
= 900 meals

18. Answer (2)
Margin of safety: The difference between the current output and the break-even output
MoS = 1,500 – 900 = 600 meals
Profit = TR – TC
TR = P x Q = £6 x 1,500 meals = £9,000
TC = FC + VC = £3,600 + (£2 x 1,500)
= £6,600
Profit = £9,000 – £6,600 = £2,400
[Have you spotted a much quicker way of calculating profit using the Margin of Safety?]
Margin of Safety = 600 meals
Contribution = £4
Profit = MoS x Contribution = £2,400

19. Break-even analysis
Katie’s Cards

20. Breakeven analysis “Katie’s Cards” question
Katie makes greetings cards. She has estimated that her fixed costs for the first six months of operation would be £3,000. The variable cost per card is estimated at 60p, and Katie set a selling price to retailers of £1.80 per card
Showing your working, calculate Katie’s break-even output for her first six months in operation
If she sells 3,000 cards, how much profit will she make?

21. Breakeven analysis “Katie’s Cards” question - answers
Contribution = £ £0.60 = £1.20
Breakeven = £3,000 ÷ £1.20
= 2,500 cards
Profit:
Margin of safety = 3,000 – 2500
= 500 cards
Profit = MoS x Contribution
= 500 x £1.20
= £600

22. Break-even analysis
MugUp task

23. Break-even analysis Task – MugUp Ltd
MugUp Ltd has sufficient capacity to produce 120,000 drinking mugs per year
The variable cost of producing each mug is 20p and fixed costs total £20,000 per year
The mugs are sold to wholesalers for 60p each
a. Calculate:
contribution per mug
break-even output
the margin of safety if current output is 90,000 mugs
profits at full capacity
b. Assuming that unit variable costs, fixed costs and capacity remain unchanged, calculate the price that MugUp would have to charge wholesalers to obtain the target profit of £40,000 per year at full capacity output

24. Task – MugUp Ltd answers (a)
Contribution per unit = 60p – 20p = 40p
Break-even output = £20,000  £0.40 = 50,000 mugs
Margin of safety = 90,000 – 50,000 = 40,000 mugs
Profits at full capacity
= Output above break-even  Contribution = 70,000  40p = £28,000
[or (Output  Contribution per unit) - FC = (120,000  40p) - £20,000 = £28,000]

25. Task – MugUp Ltd answers (b)
[Sales x Contribution per unit] – FC = Profit
[120,000 x Cont./unit] – 20,000 = 40,000
120,000 x Cont./unit = 60,000
Contribution per unit =
60,000
120,000
Contribution per unit = 50p
Price = VC + Contribution per unit
Price = 20p + 50p = 70p

26. Break-even analysis answers (b) – alternative method
Target profit:
Fixed cost + Target Profit
Contribution per unit
= Output
20, ,000
Price – 0.20
= 120,000
60,000 = 120,000 x Price – 0.20
60,000
120,000
= Price – 0.20
Price = = £0.70

27. Break-even analysis
Uses and limitations

28. Break-even analysis uses and limitations
Break-even analysis only really works for a business with one product
Involves so much simplification as to be worthless
e.g. generalising costs into fixed and variable
In reality (but not in exams!) the language of break-even is more important than the mathematics
Break-even point
Contribution
Margin of safety

29. Quiz Time Grab the boards Try the quiz 1 – basics
Quiz 2 – Break even and decision making