1. IB Business and Management
5.3 Breakeven analysis

2. Quick test: Give 2 other names for Revenue (2)
Give 2 examples of fixed costs (2)
Give 2 examples of variable costs (2)
What is the formula for Revenue? (1)
A firm has fixed costs of £2000 per month. Variable costs of £3 per unit and selling price of £5. In July they sell 1,200 units
How much revenue does the firm make? (1)
What are the firms total costs? (1)
How much profit does the firm make in July? (1)
Total marks = 10

3. Profit = Total Revenue – Total Costs
What Is Breakeven?
If a firm is breaking even it means that the business is neither making a profit or a loss. Breakeven is the output at which a firm’s total revenue is equal to its total costs.
Profit = Total Revenue – Total Costs
Questions
Do you understand what Revenue and Costs are?
What is Revenue?
How is is calculated?
What are costs?
When a business is breaking even the profit figure will be 0, can anyone tell me what Total Revenue and Total Costs need to be to get a profit figure of ?

4. Why might a firm use breakeven analysis?
New firms need to estimate how much they must produce before they make a profit
This may help them to decide if their business idea is viable
May be required as part of a business plan
Existing firms may wish to know:
Profit/Loss at any level of output
The output needed to produce a certain level of profit

5. Assumptions of simple break-even analysis
The selling price remains the same, regardless of the number of units sold
Fixed costs remain the same regardless of the number of units of output
Variable costs vary in direct proportion to output

6. Finding The Breakeven Point
The Breakeven point can be found in 2 ways
Graphical Method
Contribution method

7. Break Even Charts Costs/Revenue TR TC VC FC Output/Sales
The break even point occurs where total revenue equals total costs. The firm will have to produce and sell this number of units to breakeven
Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially.
Initially a firm will incur fixed costs, these do not depend on output or sales.
The lower the price, the less steep the total revenue curve.
As output is generated, the firm will incur variable costs – these vary directly with the amount produced. VC
The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC
Breakeven
Revenue FC
Breakeven
Output
Output/Sales

8. Example
A small Photo frame manufacturer has the following costs: Rent £5,000 per year Business Rates £2,000 per year Raw Materials £1.25 per unit Utilities £3,000 per year Packaging £1 per unit Salaries £10,000 per year The firm sells the photo frames for £4.50 to retailers How many photo frames does the firm need to produce in a year in order to break-even?

9. Step 1: Creating a Table Output Fixed Cost Variable Cost Total Cost
Total Revenue
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000

10. Example
A small Photo frame manufacturer has the following costs: Rent £5,000 per year Business Rates £2,000 per year Raw Materials £1.25 per unit Utilities £3,000 per year Packaging £1 per unit Salaries £10,000 The firm sells the photo frames for £4.50 to retailers How many photo frames does the firm need to produce in a year in order to break-even?

11. Step 2:Adding Fixed Costs
Output
Fixed Cost
Variable Cost
Total Cost
Total Revenue
20,000
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000

12. Example
A small Photo frame manufacturer has the following costs: Rent £5,000 per year Business Rates £2,000 per year Raw Materials £1.25 per unit Utilities £3,000 per year Packaging £1 per unit Salaries £10,000 The firm sells the photo frames for £4.50 to retailers How many photo frames does the firm need to produce in a year in order to break-even?

13. Step 3:Adding Variable Costs
Output
Fixed Cost
Variable Cost
Total Cost
Total Revenue
20,000
1000
2,250
2000
4,500
3000
6,750
4000
9,000
5000
11,250
6000
13,500
7000
15,750
8000
18,000
9000
20,250
10000
22,500

14. Example
A small Photo frame manufacturer has the following costs: Rent £5,000 per year Business Rates £2,000 per year Raw Materials £1.25 per unit Utilities £3,000 per year Packaging £1 per unit Salaries £10,000 The firm sells the photo frames for £4.50 to retailers How many photo frames does the firm need to produce in a year in order to break-even?

15. Step 4:Adding Total Costs
Output
Fixed Cost
Variable Cost
Total Cost
Total Revenue
20,000
1000
2,250
22,250
2000
4,500
24,500
3000
6,750
26,750
4000
9,000
29,000
5000
11,250
31,250
6000
13,500
33,500
7000
15,750
35,750
8000
18,000
38,000
9000
20,250
40,250
10000
22,500
42,500

16. Example
A small Photo frame manufacturer has the following costs: Rent £5,000 per year Business Rates £2,000 per year Raw Materials £1.25 per unit Utilities £3,000 per year Packaging £1 per unit Salaries £10,000 The firm sells the photo frames for £4.50 to retailers How many photo frames does the firm need to produce in a year in order to break-even?

17. Step 5:Adding Total Revenues
Output
Fixed Cost
Variable Cost
Total Cost
Total Revenue
20,000
1000
2,250
22,250
4,500
2000
24,500
9,000
3000
6,750
26,750
13,500
4000
29,000
18,000
5000
11,250
31,250
22,500
6000
33,500
27,000
7000
15,750
35,750
31,500
8000
38,000
36,000
9000
20,250
40,250
40,500
10000
42,500
45,000

18. Plotting the Graph Draw a set of Axis X axis= output (0-10,000)
Y axis= £ Cost/Revenue (0-50,000)
Plot the line for Total Costs
Plot the line for Total Revenues

19. Breakeven Chart TR
Costs/Revenue TC
BEP
Output

20. Answer
Breakeven output is approx 8,900
Breakeven Revenue = £40,000

21. Margin Of Safety
Margin of safety is the quantity sold which is greater than the breakeven level of output.
= Actual Output – Breakeven output
E.g. If a company has a BEP of 260 units and actually make and sell 310 units they have a margin of safety of 50

22. Break Even Charts – What they show
Costs/Revenue TR TC
Profit
Loss
Margin of safety
Breakeven
Output D2 D1
Output/Sales

23. Contribution
Contribution is the amount each unit pays towards fixed costs once variable costs have been covered.
Contribution = Selling price – Variable cost per item

24. Using Contribution to calculate the Breakeven Point
To calculate the breakeven point in terms of output the following formula can be used
Breakeven Output = Fixed Costs
Contribution per Unit
How can we work out the Breakeven Revenue?
Multiply the Breakeven output by the Selling Price

25. Questions
Work out the Breakeven Output and Breakeven Revenue for the following situations (Remember to show working out)
Fixed Cost £3,000; Variable Cost £4.25 Selling Price £8
Fixed Cost £89,000; Selling Price £99.99 Variable cost £67.31
Fixed Costs £1,000; Selling Price £1.75 Variable cost 93p

26. Answers £3,000/£3.75 = 800 units £6,400 £89,000/£32.68 = 2724 units
£272,372.76
£1000/£0.93 = 1220
£2,135

27. Contribution and the Margin of Safety
A business breaks even once they have sold enough units to cover their fixed costs:
Hence BEP = Fixed Costs
Contribution per unit
Any units sold above the break even output all of the contribution will be profit.
The number of units a business sells above the breakeven point is called the margin of safety
Therefore
Profit = Margin of Safety x Contribution per Unit

28. Changes in Variable Costs
Costs/Revenue
TC1 TR TC
TC2
If Variable Costs go up the line will become steeper. What will happen to the Break Even Point?
If Variable Costs go down the line will become less steep. What will happen to the Break Even Point?
The level of variable costs affects the gradient of the Total Costs line.
BEP2
BEP
BEP1
Output/Sales

29. Changes in Fixed Costs
Costs/Revenue
TC1 TR TC
TC2
If fixed costs go up, the Total Costs line will shift upwards
If fixed costs go down, the Total Costs line will shift downwards
The fixed cost line affects where the Total Cost line starts
BEP2
BEP
BEP1
Output/Sales

30. Changes in Selling Price
TR1
Costs/Revenue TR
TR2 TC
A decrease in the selling price will make the TR line less steep
A change in Selling price will affect the gradient of the Total Revenue line
An increase in the selling price will make the TR line steeper
BEP1
BEP
BEP2
Output/Sales

31. Example – Advertising costs increase
TC2
Costs/Revenue TR TC
An increase in Advertising causes an upwards shift of the Total Cost line. This results in an increase of the breakeven output from BE1 to BE2
BE1
BE2
Output/Sales

32. Questions
Explain what will happen to the Breakeven output in the following situations. Illustrate with a diagram.
The cost of raw materials increases
The company moves to premises with cheaper rent
The company decreases the selling price to compete with a new competitor
The electricity supplier increases their prices

33. Limitations of Breakeven Analysis
Information used may be unreliable as it is based on forecasts and predictions
Assumes SP stays the same regardless of output
Fixed Costs may not stay the same
Ignores factors such as economies of scale
Assumes that all output is sold
Only suitable for analysis of single products
Only considers quantitive factors

35. Breakeven Table Output Fixed Cost Variable Cost Total Cost
Total Revenue
Profit
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000