4.2.3 Explain, Interpret and Use a Break-Even

Chart

IGCSE Business Studies

LEARNING OBJECTIVES

• To understand the concept of break even• To be able to construct, complete or amend a

break-even chart• To be able to interpret a given chart and use it to

analyse a situation• To be able to use a chart to make decisions• To understand the limitations of break-even

charts

3

Starter – 5 mins

• Match the definition with the correct key terms

• Label the lines on break even chart

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Break-even

1. The graphicalmethod

Tutor2u Break-even simulator

Use Tutor2u’s excellent Break-even Simulator on an interactive whiteboard to demonstrate the relationships between the various variables.

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Costs and revenuetask

• Bobby Stokes makes Glory™– Materials cost £2 and overheads are £1 million per month– His factory has a capacity of 200,000 Glories™

• Bobby sells Glory™ to wholesalers for £10

• Construct a data table of his costs and revenue (FC, VC, TC, TR) for ranges of output from 0 to 200,000 units– use increments of 20,000 units

• From the data table, sketch a graph– with the y-axis scale ranging from £0 to £2,000,000

• Identify the break-even point

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Costs and revenuequick questions

• Looking at your graph, how many Glories™ must Bobby produce if he is to break-even?

• Define break-even in a single sentence• Reading from your graph, estimate the

amount of profit/loss Bobby will make if he makes and sells:– 60,000 Glories™ – 160,000 Glories™

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Break-even Simulator (Tutor2u)

task• Use the simulator to find the total contribution

and net profit when:– Selling price = £50– Variable cost per unit = £26– Fixed costs = £350,000– (Expected output = 15,000 units)

• By how much should selling price change if the firm wishes to aim for a net profit of £40,000?– What is the margin of safety at that output? What

does this mean?

• Management is reluctant to raise price. – Why do you think this might be?– How else could they try to achieve this target profit?

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Break-even analysis

2. Calculationmethod

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Calculating break-even

• Contribution: Defined as ‘the contribution that selling a single unit makes towards fixed costs and profit’

• Contribution = Price per unit – Variable Cost per unit

• Break-even point = Fixed costscontribution

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Calculating break-evenExample

• You manufacture CDs. You sell them to retailers for £8. The variable cost per CD is £1 and fixed costs are £70,000

• What is the break-even output?

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Calculating break-even Example

• A fast-food restaurant sells meals for £6 each• The variable costs of preparing and serving

each meal are £2• The monthly fixed costs of the restaurant

amount to £3,600

• How many meals must be sold each month to break even?

• If the restaurant sold 1,500 meals in April, what were the margin of safety and profit in that month?

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Break-even analysis

Katie’s Cards

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Breakeven analysis“Katie’s Cards” question

• Katie makes greetings cards. She has estimated that her fixed costs for the first six months of operation would be £3,000. The variable cost per card is estimated at 60p, and Katie set a selling price to retailers of £1.80 per card

• Showing your working, calculate Katie’s break-even output for her first six months in operation

• If she sells 3,000 cards, how much profit will she make?

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Break-even analysis

MugUp task

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Break-even analysisTask – MugUp Ltd

• MugUp Ltd has sufficient capacity to produce 120,000 drinking mugs per year

• The variable cost of producing each mug is 20p and fixed costs total £20,000 per year

• The mugs are sold to wholesalers for 60p each

a. Calculate:1. contribution per mug2. break-even output3. the margin of safety if current output is 90,000 mugs4. profits at full capacity

b. Assuming that unit variable costs, fixed costs and capacity remain unchanged, calculate the price that MugUp would have to charge wholesalers to obtain the target profit of £40,000 per year at full capacity output

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Break-even analysis

Uses and limitations

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Break-even analysisuses and limitations

• Break-even analysis only really works for a business with one product

• Involves so much simplification as to be worthless– e.g. generalising costs into fixed and variable

• In reality (but not in exams!) the language of break-even is more important than the mathematics– Break-even point– Contribution– Margin of safety

Quiz Time

• Grab the boards

• Try the quiz 1 – basics

• Quiz 2 – Break even and decision making