Meaning of break-even point
The break-even point is the level of sales at which a business's total revenues equal its total costs, resulting in neither profit nor loss. At this point, all fixed and variable costs are covered by the revenue generated from sales. The break-even point is crucial for businesses as it helps them understand the minimum sales volume needed to avoid losses.
Break-even point (Units) = Total fixed cost /Unit contribution
Example:
Fixed Costs: $10,000
Selling Price per Unit: $50
Variable Cost per Unit: $30
So, the break-even point is $ 10,000 /$ 50 - $ 30 = 500 units
Assumptions of break-even analysis
- Sales price per unit is constant.
- Variable cost per unit is constant.
- Total fixed costs are constant.
- All produced units are sold (no inventory).
- Costs are accurately divided into fixed and variable categories.
Benefits of break-even analysis
Determines Minimum Sales Requirement:
BEP analysis helps businesses identify the minimum number of units they need to sell to cover all their costs, ensuring they avoid losses. This is crucial for setting realistic sales targets.
Assists in Pricing Strategy:
By understanding the relationship between costs, volume, and profits, businesses can set appropriate prices for their products or services. It ensures that the pricing strategy will cover costs and contribute to profitability.
Evaluates Cost Structure:
BEP analysis provides insights into fixed and variable costs, helping businesses assess their cost structure. This information is valuable for cost control and efficiency improvements.
Supports Financial Planning:
It aids in budgeting and financial forecasting by providing a clear picture of the financial viability of various business scenarios. Businesses can plan for different levels of production and sales to achieve desired financial outcomes.
Informs Investment Decisions:
BEP analysis helps businesses evaluate the potential profitability of new projects or investments. By calculating the break-even point, businesses can assess whether an investment will generate sufficient returns to justify the costs.
Limitations of break-even analysis
- Assumes constant sales price.
- Assumes constant variable costs.
- Assumes all units produced are sold.
- Ignores changes in market conditions.
- Does not account for economies of scale.
Exercise:
You are given the following cost and revenue details
| Business A | Business B | |
|---|---|---|
| Fixed cost | $20,000 p.a. | $40,000 p.a. |
| Variable cost | $120 per unit | $60 per unit |
| Selling price | $200 per unit | $100 per unit |
| Current output (Annual) | 400 units | 1200 units |
Questions:
A) Identify five assumptions of break even graph [ 2 marks]
B) Calculate unit contribution for both Business A and Business B [ 2 marks]
C) Calculate break even quantity for both Business A and Business B
[ 4 marks]
D) Calculate break even revenue ($) for both Business A and Business B
[ 4 marks]
E) Calculate profit at the current level of output for both Business A and Business B [ 4 marks]
Multiple Choice Questions
Report Card
Total Questions Attempted: 0
Correct Answers: 0
Wrong Answers: 0
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