2.2.3 break even

break even

• the point at which a business is not making a profit or a loss

• at this point total cost = total revenue

• break even output: the number of items that a business must sell to reach this point

formulas

• contribution per unit = selling price - variable cost

• break even point = fixed cost / contribution

• total contribution = total sales revenue - total variable cost

• margin of safety = actuals sales - breakeven level of sales

changing variables

• fixed cost:

  • landlord puts up rent

  • bank changes interest rates

  • pay increase

• variable costs:

  • raw materials change in price

  • minimum wage increases

  • utility companies change prices

• selling price:

  • new competition

  • positive word of mouth puts up demand

strengths of break even

• allows business to calculate minimum number of sales needed before starting to make profit and therefore see if venture is viable

• can calculate level of profit or loss at different levels

• can predict the outcome of changing variables

weaknesses of break even

• is based on predicted costs an revenue

• ignores change in variable costs or selling price as items are sold in larger quantities

• only indicates number of sales needed and doesn’t ensure actual sales will materialise

what is margin of safety

the difference between actual sales and the sales needed to break even