Recap

Fixed or variable

Security

Insurance

Electric

Workers

Telephone

Raw Materials

Accountant

Financial management

Learning ObjectivesIntroduction to break-evenDefine and calculate contributionDefine and calculate contribution per unitIdentify the relationship between

contribution, profit and pricingAssess the relationship between break – even

and contribution

What is Break - even?It is the point at which a company is not

making a loss or a profit.The business income equals its expenditures. It is a significant marker as it allows

management to know the level of output required to sustain and succeed.

It can be used to help determine pricing strategy, budgets, quality and output quantity.

It is where Costs = Revenue within a business.Always measured in production units never

cost

Terms to be familiar withVariable costs = changes depending on

output.Fixed costs (fixed overheads) = remains the

same no mater how much is producedTotal cost = Fixed cost + variable costsProfitLoss

Terms to be familiar continuedOutputContribution Revenue (Sales revenue) = when firms get

money from selling their products / servicesMargin of SafetyBreak – even point

Variable costsVariable costs correlate to outputThis could be the price of ink, or fabric within

a T-shirt factory.Variable costs can be reduced by reducing

waste, finding cheaper suppliers or streamlining the production process

Fixed costsRemain the same irrespective of outputCould be

Rent Rates Salaries Accountancy costs Most marketing costs Leasing equipment costs

RevenueRevenue is the amount of capital (money)

brought in by the firm form sales of goods or services.

Revenue is calculated before any expenses are deducted.

If a firm sold 10 T-shirts at £15 within a specific timeframe (say a month) total revenue for that month would be £150

Revenue alone is NOTHING to do with profit!!

What is Break – even analysis?It is a technique widely used by production

management and management accountants. It is based on categorising production costs

between those which are variable (costs that change when the production output changes)

and those that are fixed (costs not directly related to the volume of production).

Calculating the Break – even pointThere are two ways to calculate the break-

even point. The two ways are as follows:

The contribution methodProducing a break–even chart

ContributionEssentially the difference between revenue

(sales) and variable costs.For example if a shirt sells at £25 (revenue)

and it costs £5 for the material and £3 for the ink for the prints on the shirt the variable costs would be £?.

The contribution per unit would be £17£25 - £8 = £17

revenue - V.C. = contribution

£8

Contribution MethodThis involves a two part calculation:

Revenue (selling price) per unit – variable cost per unit = contribution (towards fixed costs).

ANDFixed costs / contribution = break-even point.

ExampleIf fixed costs = £2000, variable costs = £8 per unit, selling Price per unit =£10. Then break-even would be:

Price per unit – variable cost per unit = contribution (towards fixed costs).£10 - £8 = £2 (contribution, towards fixed costs)

Fixed costs / contribution = break-even point.£2000 / 2 = 1000

1000 products will need to be sold in order to break-even and cover all their costs.

TaskLisa has set up a business to print T-shirts.

The fixed costs of premises and the T-shirt printers are £3000. The variable costs per T-shirt (the T-shirt, ink, wages) are £5. Each printed T-shirt sells for £25.

NOW YOU TRY!

Task AnswerLisa has set up a business to print T-shirts. The fixed costs of premises and the T-shirt printers are £3000. The variable costs per T-shirt (the T-shirt, ink, wages) are £5. Each printed T-shirt sells for £25.

Revenue per unit – Variable Cost Per Unit = Contribution

£25 - £5 = £20 (Contribution per unit)

Fixed Costs / Contribution per unit = Break-even Point.£3000 / 20 = 150

Lisa must sell 150 T-shirts to brake even

Task 2 Rebecca starts a business making and selling

handbags and has the following costs:

Fixed Costs £50,000 per yearVariable Costs £15 per handbagSelling Price £55 each

Calculate the break-even point?

Answer

Revenue – Variable Cost = Contribution £55- £15 = £40 (Contribution)

Fixed Costs / Contribution = Break-even Point.

£50,000 / £40 = 1250

Rebecca has to sell 1250 handbags to brake even.

Break – even chart

A break-even chart can demonstrate the effects of change in price of products / services

Units produced

Fixed cost Variable cost

Total cost

1 15,000 20 15,020

50 15,000 1,000 16,000

100 15,000 2,000 17,000

150 15,000 3,000 18,000

200 15,000 4,000 19,000

250 15,000 5,000 20,000

T.R.

&

Costs

Production

Fixed Cost

T.R.&

Costs

Production

Fixed Cost

T.R.&

Costs

Production

Fixed Cost

Total Cost

T.R.&

Costs

Production

Fixed Cost

Total Cost

Total Revenue

T.R.&

Costs

Production

Fixed Cost

Total Cost

Total Revenue

Break - even Point

T.R.&

Costs

Production

Fixed Cost

Total Cost

Total Revenue

Break - even Point

Margin of safety

Area of profit

Margin of safetyThe margin of safety represents the total

current output and total revenue.It shows the current level of output at a point

on the total revenue line.The difference between current output and the

break – even point is the margin of safety.Businesses need to be aware of the margin of

safety as it shows the extent demand for their products and services can drop before they start making a loss

Start of chartStart by compiling a simple grid to calculate

total costs at certain quantities of production, plotting your chart is made a lot easier.

Units produced

Fixed cost Variable cost

Total cost

1 15,000 20 15,020

50 15,000 1,000 16,000

100 15,000 2,000 17,000

150 15,000 3,000 18,000

200 15,000 4,000 19,000

250 15,000 5,000 20,000

Task for graph paper 1. Mark is selling 16GB USB pen sticks on a market

stall. The pen sticks cost him £4.80, he sells them at £9.00. His market stall rent is £100 on Saturday. Using the graph paper provided make a break-even chart to determine how many pen sticks Mark will have to sell to break-even.

2. Mark has also been offered the same stall on Sunday at a discounted rate for £60, Using the same chart calculate how many items he will need to sell to break-even on Sunday

Questions???