TOPIC: Topic 5: Operations Management LESSON TITLE: Break-even Analysis

COMPETENCY FOCUS:

Key Skills (L5): you will be able to develop your numeracy skills to calculate financial transactions of a business and to interpret financial data.

Learning ObjectivesBy the end of the lesson, you should be able to…

To calculate break even using the correct formulae (Gui-Reg)

To calculate break-even using the graphical method.

Introduction to Break Even

• To make a profit, revenue must be higher than costs.

• It is where Costs = Revenue within a business.

• New businesses should always conduct a break-even analysis to find the break-even point. This tells them how much they need to sell to break even.

Is the business breaking even?

CoolMobile Ltd makes fun cases for mobile phones.

Each case sells for £6.

Fixed costs per year are £10,000 and variable costs are £2 per case (unit). The maximum cases that the company can make in 1 year is 6000.

Use this data to construct a clear table.

Is the business breaking even?

Units of Output (Cases)

Fixed Costs (£)

Variable Costs (£)

Total Costs (£)

Total Revenue

(£)

Profit or loss?

0

500

1,000

1,500

2,000

6,000

Test your knowledge…

1) What does the term break-even mean? [2]

2) Why is it important for a business to calculate their break-even? [2]

3) What does break-even analysis show a business? [1]

[Max 5marks]

Where is the Break-even Point (BEP)?

Calculating Break-Even Point (BEP)

• There are two ways to calculate the break-even point (BEP):

– USING A FORMULA (CONTRIBUTION METHOD)

– PRODUCING A BREAK EVEN CHART.

BREAK-EVEN POINT (BEP)= the point at

which revenue equals expenditure!

CONTRIBUTION METHOD (FORMULA)

This involves a two part calculation:

• Selling Price per unit – Variable Cost Per Unit = Contribution (Towards Fixed Costs).

AND• Fixed Costs / Contribution = Break-even Point.

Calculating Break-Even Point (BEP)

• There are two ways to calculate the break-even point (BEP):

– USING A FORMULA (CONTRIBUTION METHOD)

– PRODUCING A BREAK EVEN CHART.

BREAK-EVEN POINT (BEP)= the point at

which revenue equals expenditure!

CALUCULATING BREAK-EVEN POINT USING GRAPH

Break-even graphs show costs and revenue plotted against outputOutput goes on the horizontal axis (starting from 0)Costs and revenue both go on the vertical axis

STEP 1: draw you axis, label ‘y’ axis ‘costs/revenue’ & label ‘x’ axis with ‘No of units sold’

STEP 2: Draw your fixed costs line

STEP 3: Add your total costs line (calculate the total costs for two points on graph & draw best-fit line)

CALUCULATING BREAK-EVEN POINT USING GRAPH

STEP 4: Draw your sales revenue line (again calculate this for two points on graph and draw in best-fit line)

STEP 5: Draw & label your BE point where your total costs and sales revenue lines

cross over.

Key Words

Margin of Safety: The amount by which demand can fall before a business makes a loss.

Task - Evans Cricket Bats Ltd

Fixed costs = £40,000 Variable costs £2 per cricket bat Total costs = Fixed + variable costs Sales revenue = Selling price x output Cricket bats sold for £35 each

Output (No of cricket bats)

Fixed costs

Variable costs

Total costs Sales revenue

1,000 £40,000

2,000 £40,000

3,000 £100,000

4,000 £140,000

Stage 1: calculating costs & revenue

Fixed costs = £40,000 Variable costs £2 per cricket bat Total costs = Fixed + variable costs Sales revenue = Selling price x output Cricket bats sold for £35 each

Output (No of cricket bats)

Fixed costs

Variable costs

Total costs Sales revenue

1,000 £40,000 £20,000 £60,000 £35,000

2,000 £40,000 £40,000 £80,000 £70,000

3,000 £40,000 £60,000 £100,000 £105,000

4,000 £40,000 £80,000 £120,000 £140,000

Stage 2: DRAW the graph

Turn your paper so it is LANDSCAPE and copy this.C

osts

(£)

Output (No of cricket bats)

1000 2000 3000 4000

Stage 3: Showing costs on a graph.

Insert fixed costs.

Cos

ts (

£)

Output (No of cricket bats)

1000 2000 3000 4000

Stage 3: Showing costs on a graph.

Calculate total costs.

Cos

ts (

£)

Output (No of cricket bats)

1000 2000 3000 4000

Total costs

Variable costs

Fixed costs

Stage 4: Showing revenue on a graph

Now add revenue to your graph.

Cos

ts (

£)

Output (No of cricket bats)

1000 2000 3000 4000

Total costs

Variable costs

Fixed costs

Stage 4: Showing revenue on a graph

Now add revenue to your graph....

Cos

ts a

nd s

ales

re

venu

e (£

)

Output (No of cricket bats)

1000 2000 3000 4000

Sales revenue

Total costs

Variable costs

Fixed costs

Stage 5: revealing the break-even pointBreak-even is point is where revenue line

crosses the total costs line.

Cos

ts a

nd s

ales

re

venu

e (£

)

Output (No of cricket bats)

1000 2000 3000 4000

Sales revenue

Total costs

Variable costs

Fixed costs

Is the business breaking even?

CoolMobile Ltd makes fun cases for mobile phones.

Each case sells for £6.

Fixed costs per year are £10,000 and variable costs are £2 per case (unit). The maximum cases that the company can make in 1 year is 6000.

Use this data to construct a clear table.

Is the business breaking even?

Units of Output (Cases)

Fixed Costs (£)

Variable Costs (£)

Total Costs (£)

Total Revenue

(£)

Profit or loss?

0

500

1,000

1,500

2,000

6,000

Is the business breaking even?

Use your table to construct a break-even graph.

This can be done using graph paper.

TASK 1

Complete task on pg.68/69.

TASK 2

Complete activities in the break-even workbook.

[40mins]

The Importance of Break-even

- Helps a business make decisions about the business

- Calculate the effect of a change in price

- Calculates the effect of a change in costs

- Estimates the level of output needed to cover costs

- Provides evidence to the bank when applying for a loan.

The Limitations of Break-even

It assumes that the firm can sell any quantity of the product at the current price. In practice the firm may need to reduce prices to sell at high levels of output.

It assumes fixed costs never change - but as output increases the firm may need to buy more machines, get bigger premises, take on extra sales and administration staff.

It assumes that all products are sold. This doesn’t always happen; some products may only be sold at

lower prices or need to be thrown away.

Impact of changing cost or price on BEP

What is the impact on the BEP if CoolMobile Ltd increase their selling price from £6 to £7 per unit?

What is the impact on the BEP if CoolMobile reduced their variable costs from £2 to £1 per unit.