2. Craig Dudden
• …determines the point at which
a business neither makes a
profit or loss.
• …all costs are covered by a
particular volume of output
3. Craig Dudden
Mp3 Player
Expected selling price
£150
Direct costs
(variable costs)
Indirect costs
(Fixed costs)
Direct materials
Direct labour
Direct expenses
£50
£30
£20
£100
Factory rent
£50,000 p.a
(per annum)
a) Contribution per unit = Selling price - Variable costs
£50 = £150 - £100
b) Break Even Point is calculated by:
c) at BEP: Total Costs = Total Revenue
(1,000 units x VC £100)+ FC £50,000 = 1,000 units x SP £150
£150,000 = £150,000
£50,000
£50
= 1,000 units
6. Craig Dudden
Break Even Chart
• Takes considerable time to work out the BEP using
this method.
0
250 500 750 1000 15001250
225,000
200,000
175,000
150,000
125,000
100,000
75,000
50,000
25,000
Fixed costs (FC)
Variable costs (VC)
Total Revenue (TR)
Total Costs (TC)
Volume or Output (units)
Cost,Revenue(£)
7. Craig Dudden
Uses of Break Even Analysis
• Break even analysis is particular
useful when making decisions
regarding the launch of new
products or services, or
diversification into new markets.
• When launching a new product
it is important to know the level
of output and sales needed to
break even. This can be
calculated by dividing fixed
costs by contribution per unit.
8. Craig Dudden
Margin of Safety
• From the break even quantity we can calculate the excess of
sales over break even. This is known as the margin of safety. The
formula is: actual output minus break even output. The higher
the margin of safety is, the greater the profits. In fact, think of it in
terms of once break even has been reached, each unit
contribution now adds to the firm’s profits.
• If we multiply the margin of safety by contribution per unit we
get the level of profits.
Profit = margin of safety X contribution per unit
We can vary the formula to calculate the level of output needed
to achieve a target level of profits. What we do here is to add
the profit target to fixed costs and the simply work out the
number of unit contributions needed to achieve this level of
profit. Thus, the formula is:
Fixed costs + profit target
Contribution per unit
9. Craig Dudden
Summary
At the break even level of output and
sales (note only when the output is sold
does it contribute to sales revenue), is
when the firm is neither making a profit
nor a loss. It is when sales revenue covers
costs, but no more than that.
Logically, if output and sales are below
the break even level then the firm is
making a loss, whereas if output and sales
are above the break even level then it is
making a profit. The higher the level of
output and sales above break even, the
greater the profit.
10. Craig Dudden
Summary
At the break even level of output and
sales (note only when the output is sold
does it contribute to sales revenue), is
when the firm is neither making a profit
nor a loss. It is when sales revenue covers
costs, but no more than that.
Logically, if output and sales are below
the break even level then the firm is
making a loss, whereas if output and sales
are above the break even level then it is
making a profit. The higher the level of
output and sales above break even, the
greater the profit.
