Break-even analysis

5.5 Oxford textbook

Break-even quantity

Break-even quantity is the minimum amount of products needed for a business to sell in order to make a profit. 

Contribution

Contribution is how much a product contributes to the fixed costs of a business. It's the money made and can be used to support other parts of the business.

• Contribution is not the same as profit. Contribution is used to pay other costs in a factor and its reminder is profit. 

Contribution per unit

price per unit - variable cost per unit. 

Total contribution

total sales revenue - total variable costs

Profit

total contributions - total fixed costs

Break even point

There is no loss nor profit

Break even chart

Numerically or graphically calculation of break even point

Margin of safety

Margin of safety is where the output amount exceeds the break even quantity. 

Margin of safety = current output - break-even output

Contribution per unit method

break even quantity = fixed costs/ contribution per unit.

Profit

• Profit = total contribution - total fixed costs 

• Profit = Total revenue - total costs 

Target profit output

Target profit output is the level of output that is needed to earn a specified amount of profit. 

Target profit output

Target profit output = fixed costs + target profit / contribution per unit

Break even revenue

break even revenue = fixed costs /contribution per unit * price per unit

Benefits of break-even analysis

• Visualise a firm’s profit or loss

• Can determine a firm’s margin of safety 

• Calculations can back-up the graph

• The impact of changes in price and costs can be observed visually. 

• Strategic decision making tool.

Limitations

• Assumes all units produced are sold, which isn’t always the case. Businesses usually have stocks which aren’t accounted for in the analysis and sometimes the extra stock isn’t even sold. 

• Assumes that all costs and revenues are linear but discounts could change that. 

• Fixed costs may change at different levels of activity. 

• Semi-variable costs are not usually represented such as an increase in wages. 

• Not useful in a dynamic business environment. 

• Unreliable or inaccurate data may influence the conclusions reached, leading to wrong decisions being made.