Break-even Analysis
Revenues, costs and profits
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Richard Repairs – your local garage repair service.
Reminder for November and December trading. Looks OK. Yes?
The more repair jobs he does, the higher his profits. Why?
What would happen if he did fewer?
Estimates for November and December
November
December
100
120
£100
£100
£10,000
£12,000
D Salaries
£2,000
£2,000
E Other fixed costs
£1,000
£1,000
£3,000
£3,000
£50
£50
A Number of Jobs
B Price charged per job
C Total revenue
F Total fixed costs
=AxB
=D+E
G Variable costs per job
H Total variable cost
=AxG
£5,000
£6,000
I Total costs
=F+H
£8,000
£9,000
=C-I
£2,000
£3,000
J Profits
Revenues, costs and profits
• Looking back at November and December, it was a bad Christmas perhaps too many people went away
• Did he make a profit or loss in November and December. Fill in
Actual
November
December
80
60
£100
£100
D Salaries
£2,000
£2,000
E Other fixed costs
£1,000
£1,000
£3,000
£3,000
£50
£50
A Number of Jobs
B Price charged per job
C Total revenue
F Total fixed costs
=AxB
=D+E
G Variable costs per job
H Total variable cost
=AxG
I Total costs
=F+H
J Profits
=C-I
Break-even
• New businesses may not make
profits in the first few months or
even first year after starting
• They will of course make
estimates for revenues, costs
and profits, based on market
research
– In particular businesses will want to
know how what sales are needed in
order to break-even
• If Richard has 60 repair jobs he
breaks even
– More than 60 jobs means he makes
a profit
– Less than 60 jobs, he makes a loss
Jobs
Revenue
Total Costs
40
£4,000
£5,000
50
£5,000
£5,500
60
£6,000
£6,000
70
£7,000
£6,500
80
£8,000
£7,000
Calculating break-even
• He broke even in December
• Break-even output is the level of output where total revenue equals total
costs
• This means the minimum sales needed to cover costs.
– Output less than break-even means a loss, higher output a profit
• How can we calculate the break-even point?
– Fixed costs are £3,000. 30 jobs at £100 means £3,000 revenue. Is this break-even?
– Need to cover variable costs as well. Each job brings in £100 in revenue, but adds £50 to
costs
– So each extra job contributes £50 towards fixed costs. This is calculated as
selling price – variable cost per unit
– So what might the formula be?
Break-even output =
Fixed costs
Selling price per unit – variable cost per unit
Break-even charts
12,000
10,000
8,000
Fixed cost
Variable cost
6,000
Total cost
Revenue
4,000
2,000
0
10
20
30
40
50
60
70
80
90
100
Examples
• Burger stall opens on Surbiton Crescent. Sells delicious
burgers for £1.50. He has to pay £50 each day to Kingston
Borough Council, and a further £50 for the cost of his stall.
Each burger costs 50p in raw materials and cooking. How
many does he have to make to break-even.
• Great new local boutique, Jenny’s Jeans, selling designer
brand jeans for £40 each. A steal. The fixed costs of the shop
are £1,500 per month, and each pair of jeans costs Jenny £15.
How many jeans must she sell in a month to break-even?
• Draw approximate breakeven charts for above
Contribution
• The idea behind contribution is that each unit sold contributes to
covering fixed costs
– If selling price is £2.00 and each unit (say a burger) has variable cost of
£0.50, then each extra burger sold contributes £1.50 to paying fixed costs
• Contribution per unit is therefore selling price (per unit) minus
variable cost per unit
• Total contribution measures how much all sales made have
contributed towards paying fixed costs
– This is measured by number of units sold times contribution per unit
– For example 100 burgers sold means a total contribution of 100 x £1.50 =
£150
– This is the same as total revenues minus total variable costs, which would
be 100 x £2.00 minus 100 x £0.50, which is £200 - £50 =£150
Margin of safety
the amount by which current output exceeds break-even output
12,000
10,000
8,000
Fixed cost
6,000
Total cost
Revenue
4,000
2,000
0
10
20
30
40
50
60
70
80
90
100
Usefulness of break-even
• First and most basic it enables a business to know what sales
it needs to achieve to make a profit
• Can estimate profits or losses at different levels of output
• Gives margin of safety – how far sales are above break-even
• Can show what happens to profits and break-even if:
– Fixed costs change
– Variable costs change
– The business changes its price
Break-even output =
fixed costs
selling price per unit – variable cost per unit
=
fixed costs
contribution per unit
What happens if:
1. Fixed costs increase (and nothing else changes)
Then fixed costs ÷ contribution per unit will increase, so break-even output increases. Since
contribution per unit is the same, a firm will have to sell more to cover the increased in fixed costs
If fixed costs fall, then break-even output falls
2. Variable cost per unit increases
Then contribution per unit falls (selling price per unit minus variable cost per unit decreases), so
break-even increases. Since the contribution from each unit sold decreases, a firm will need to sell
more to cover fixed costs
If the variable cost per unit decreases, then break-even output is lower because contribution per
unit is higher so fewer units need to be sold to cover fixed costs
3. Selling price is decreased
Then contribution per unit decreases (selling price minus variable cost per unit decreases), so
break-even output increases. Since the contribution from each unit sold decreases, a firm needs to
sell more to cover fixed costs
If the price is increased, then break-even will decrease (because contribution per unit increases so
fewer units need to be sold to cover fixed costs)
Break-even output =
1.
Fixed costs
Selling price per unit – variable cost per unit
Assume fixed costs increase from
£3,000 to £4,000 per month. Breakeven will increase to 80 jobs:
£4,000 ÷ (£100 - £50)
= £4,000 ÷ £50 = 80 jobs
2. Say fixed costs do not change but
variable costs increase to £60 per job.
Break-even will increase from 60 to 75
jobs:
£3,000 ÷ (£100 - £60)
= £3,000 ÷ £40 = 75 jobs
3. Say neither fixed costs or variable
costs change, but Richard cuts the
price to £80 (to get more business),
then break-even rises from 60 to 100
jobs:
£3,000 ÷ (£80 - £50)
= £3,000 ÷ 30 = 100 jobs
=
Fixed costs
Contribution per unit
Richard Repairs
– Fixed costs £3,000 per month
– Selling price £100
– Variable cost per unit £50
Breakeven is therefore:
£3,000 ÷ (£100 - £50) = 60 jobs
Weaknesses