5.5 Break-even analysis BM

Break-even

when a firm’s sales revenues cover all of its production costs.

Break-even quantity

the level of output where a business does

not make either a profit or a loss. The formula for calculating the BEQ is:

Contribution per unit / unit contribution

the amount of money earned from each unit of the product sold to customers.

Selling Price - AVC

Total contribution

(P-AVC)Q

Profit

positive difference between a firm's total revenue

and its total costs. Profit is shown in a break-even chart at all

levels of output beyond the break-even quantity.

[(P-AVC)Q]-TFC

Value added per unit

P - ATC

Margin of Safety

numerical difference between how much the business sells and its BEQ

Quantity sold - BEQ

Target profit output (or target profit quantity)

quantity of sales required to reach the firm’s target profit. It is calculated using the formula:

Target profit quantity = (Fixed cost + Target profit) / (Price – Average Variable Cost)

Target profit

the amount (value) of profit that a firm aims to earn within a given time period. The target profit for each level of output can been seen in a break-even chart by comparing the total cost and total revenue lines.

Target price

the amount customers need to pay per unit in order for the firm to break-even or to reach

a particular target profit. The formula used to calculate the target price for break-even is:

• Target price = Average Fixed Cost + Average Variable Cost

• or

• Target price = (Total Fixed Cost ÷ Output) + Average Variable Cost

The formula used to calculate a target price beyond break-even is:

• Target price = (Target profit + Total cost) / Quantity of output

• The formula to calculate a specific target profit is:

• Target profit = Price × Quantity – [Fixed cost + (Average variable cost ×

Quantity)]

• or

• Target profit = Total revenue – Total cost

Contribution

the difference between the sales revenue earned from

selling a product (its price) and the variable costs of producing the product.

• Unit contribution = P – AVC

Break even analysis

a decision-making tool used to calculate the level of sales needed to cover all costs of production. Any sales beyond the break-even point generate a positive safety margin and hence profit for the business.

Break-even chart

a diagrammatic representation of a firm's

costs, revenues and profits ( or loss) at various levels of output.

Break-even point

the position on a break-even chart

where the total cost line intersects the total revenue line. This is

shown at the point where TC = TR.

Loss

firm's total costs exceed its total revenues

(TC > TR). This occurs at all levels of output or sales below the

break-even quantity.