Break Even

Training guide to break even analysis.

What is breakeven analysis?

Break even analysis is a calculation to show at what point you are making no profit or loss, so it is when a businesses total revenue covers total costs so it is to show how much output you will have to produce to cover your total costs, within a business. Break even is usually shown in the form of a graph. To work out the break even point of a business you need 3 important components which are:

1. Fixed costs, which are not usually associated with production- these are costs that are at a set price and will not change if income is high or low e.g. Rent and insurance.

2. Variable costs- these are costs that change depending on amount of use and output of sales and the capacity of production e.g. Electricity, parts and materials.

The fixed costs and the variable costs amount to the total costs.

3. Selling price- The price at which they are going to sell their product or service.

When you have calculated break even and found the point at which it is you can then work out where your margin of safety is. Margin of safety is where a business can see at which point they will start making a loss, so on a break even graph the margin of safety would be at the break even point and above as if they went below the break even point they would start to make a loss.

Below there is a break even graph, this will help you to understand break even. As you can see the break even point is represented with the letter P and it is the total revenue line in the blue and the total costs line in the red that cross to give the break even point. If the business goes below the dotted break even line then they will be making a loss but if they are over the break even line they will be in profit. The straight line in the grey at the bottom represents the fixed costs.

www.tutor2u.net The site that the graph is from.

Break evens uses;

1. It can be used to show how much output the business will have to produce to cover the total costs.

2. It may be used to set production aims e.g. the business needs to increase production etc. It can be used to set aims and objectives to reach break even or to make a percentage of profit over break even in a certain amount of time and it can monitor these aims.

3. It can help a business to decide the price of a product.

4. It can be used to help with decision making, such as do the business need to push sales or increase the price.

5. It can be used to study how changing fixed costs and variable costs will affect profit levels.

The problems with break even;

1. On a break even chart it assumes that all of the output is sold.

2. The price you first set may be too low and break even may not be achievable so you may have to change your prices.

3. It assumes that if you increase production you will be paying the same variable costs, but this is not so as the output the higher the variable costs.

4. If you have reduced pricing for bulk buyers, your costs won't change and your sales revenue will be lower.

5. It assumes that all fixed costs are the same price throughout, however there may be a period where it will cost more.

Why is break even crucial to a business?

Break even is very useful to a business as it can help management considerably to make decisions, these decisions may include; if the business will need to increase production capacity, they can see how far off from break even they are or they may be at break even and want to make a profit. So the break even graph will enable them to see how much more output is needed to reach break even or profit. So in other words a break even graph can help a business to set profit or production targets and these targets can be monitored on the break even chart. The break even graph is also needed by a business because if they didn't have there break even point worked out they would never know if they were making a loss until it would be too late, as the business would probably over spend and they may be selling their product at a cheaper price as they think that it is going to give them a profit, but in reality if they are over spending and not selling enough of the product or are not selling the product at the right price