This document discusses contribution and breakeven analysis. It defines contribution as the selling price of an item minus its variable costs of production. Total contribution is the sum of individual contributions or total revenue minus total variable costs. Breakeven analysis determines the output level where total revenue equals total costs. It can be calculated using a table showing costs and revenues at different output levels, a formula of fixed costs divided by individual contribution, or a graph where total revenue and total costs lines intersect.

1. Breakeven analysis
1.12 - GRAHAM WILSON

2. Contribution

A product makes a ‘contribution’ towards the profit of
a business.

Knowing the contribution is important in deciding
whether to produce the item or not. If it contributes a
lot, then you will want to produce it, but if it only
contributes a little (or worse still, has a negative
contribution) then you won’t want to.

All businesses have FIXED COSTS. We ignore these in
calculating contribution.

For a single item, the CONTRIBUTION is the SELLING
PRICE minus the VARIABLE COSTS to produce it. (c = s –
v)

If a pot of yoghurt sells for £1 and the variable costs to
make it are 40p then its contribution is 60p.

3. Contribution (2)

The TOTAL CONTRIBUTION (TC) is the sum of all the individual
contributions.

If we produce 1000 pots of yoghurt then the TC is 1000 x 60p or £600.

So, TC = n x C

Another way of calculating TC is to look at production overall. TC is
the difference between Total Revenue and the Total Variable Costs.

In other words, by selling all our pots of yoghurt, we generate £1000.
The variable costs of our ‘dairy’ are £400, so the TOTAL
CONTRIBUTION is £600.

4. Breakeven analysis

… is the study of the relationship between total costs and total
revenue to work out how much output has to be produced to
‘break even’.

Breakeven output is the volume of output at which total sales
revenue is the same as the TOTAL costs of production.

There are three ways of calculating breakeven output:
1.
Using a table
2.
Using a formula
3.
Using a graph

5. Breakeven analysis by table
Pots
Revenue
Variable C
Fixed C
Total Costs
Profit
£1
40p
£900
0
£0
0
£900
£900
-£900
1000
£1000
£400
£900
£1300
-£300
2000
£2000
£800
£900
£1700
£300
3000
£3000
£1200
£900
£2100
£900
4000
£4000
£1600
£900
£2500
£1500
5000
£5000
£2000
£900
£2900
£2100

6. Breakeven analysis by formula

The contribution (c) is the amount of money that each item sold (n)
contributes to, firstly paying off the fixed costs (f), and then making a
profit.

So, the breakeven output is the number of items that just pay off the
fixed costs.

Breakeven output, N = F / c

In other words, the breakeven output is the Total Fixed costs divided
by the individual contribution

Breakeven output of yoghurt pots = £900 / 60p = 1500

7. Breakeven analysis by graph
The crossing
point is where
total revenue
equals total
costs
Yoghurt pots
6000
Sales Revenue
5000
4000
3000
2000
1000
0
1000
2000
3000
4000
Units of output
Revenue
Fixed costs
Total costs
5000