Break Even

Break even - when a business isn’t making a profit or loss

break even point = fixed costs/contribution per unit

contribution per unit = selling price per unit - variable cost per unit

total contribution = total revenue - total variable costs

Contribution - how much you have left to cover fixed costs

• Once all fixed costs have been covered, the business can make a profit

• Variable costs are deducted first as they are the costs of production e.g. wages, materials etc. - if production can’t take place then the products can’t be sold

break even output- how many units needed to sell to break even

break even output = fixed costs/contribution per unit

Margin of safety - difference between actual output and break even output

• A business operating with a positive margin of safety is profitable

• A negative margin of safety means the business is making a loss

profit = margin of safety (units) x contribution per unit

Limitations of break even analysis:

• Businesses can be unrealistic in their expectations

• Assumes production and sales are the same

• Inaccuracies

  • Demand changes regularly

  • Variable costs change regularly

  • External shocks

• Time consuming

Advantages of break even analysis:

• Shows how many products to sell before making a profit

  • Is it too risky to sell the product?

• Analyses the relationship between fixed costs and variable costs