1. Break Even Analysis

2. …determines the point at which a business neither makes a profit or loss.
…all costs are covered by a particular volume of output

3. Expected selling price £150
Indirect costs (Fixed costs)
Direct costs (variable costs)
Direct materials
Direct labour
Direct expenses
£50
£30
£20
£100
Factory rent
£50,000 p.a (per annum)
Mp3 Player
Expected selling price £150
a) Contribution per unit = Selling price - Variable costs
£50 = £ £100
b) Break Even Point is calculated by:
c) at BEP: Total Costs = Total Revenue
(1,000 units x VC £100)+ FC £50, = ,000 units x SP £150
£150,000 = £150,000
£50,000
£50
= 1,000 units

4. Break Even Chart
Takes considerable time to work out the BEP using this method.
225,000
Total Revenue (TR)
200,000
Total Costs (TC)
Cost, Revenue (£)
175,000
150,000
Variable costs (VC)
125,000
100,000
75,000
50,000
Fixed costs (FC)
25,000
250
500
750
1000
1250
1500
Volume or Output (units)

5. Uses of Break Even Analysis
Break even analysis is particular useful when making decisions regarding the launch of new products or services, or diversification into new markets.
When launching a new product it is important to know the level of output and sales needed to break even. This can be calculated by dividing fixed costs by contribution per unit.

6. Margin of Safety
From the break even quantity we can calculate the excess of sales over break even. This is known as the margin of safety. The formula is: actual output minus break even output. The higher the margin of safety is, the greater the profits. In fact, think of it in terms of once break even has been reached, each unit contribution now adds to the firm’s profits.
If we multiply the margin of safety by contribution per unit we get the level of profits.
Profit = margin of safety X contribution per unit
We can vary the formula to calculate the level of output needed to achieve a target level of profits. What we do here is to add the profit target to fixed costs and the simply work out the number of unit contributions needed to achieve this level of profit. Thus, the formula is:
Fixed costs + profit target
Contribution per unit

7. Summary
At the break even level of output and sales (note only when the output is sold does it contribute to sales revenue), is when the firm is neither making a profit nor a loss. It is when sales revenue covers costs, but no more than that.
Logically, if output and sales are below the break even level then the firm is making a loss, whereas if output and sales are above the break even level then it is making a profit. The higher the level of output and sales above break even, the greater the profit.