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    Business Note

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    chinhour thav
    Breakeven analysis determines the minimum level of production or sales needed for a business to break even. It calculates the point where total revenue equals total costs. Production above the breakeven level yields profit, while production below results in losses. Breakeven can be calculated using formulas that consider fixed costs, variable costs per unit, and selling price. It is useful for determining profit levels and the impact of price/cost changes, though it assumes linear costs and sales and may not reflect real-world complexities like unsold inventory or multi-product businesses.

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    Business Note

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    chinhour thav
    23 views3 pages
    Breakeven analysis determines the minimum level of production or sales needed for a business to break even. It calculates the point where total revenue equals total costs. Production above the breakeven level yields profit, while production below results in losses. Breakeven can be calculated using formulas that consider fixed costs, variable costs per unit, and selling price. It is useful for determining profit levels and the impact of price/cost changes, though it assumes linear costs and sales and may not reflect real-world complexities like unsold inventory or multi-product businesses.

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    Breakeven analysis determines the minimum level of production or sales needed for a business to break even. It calculates the point where total revenue equals total costs. Production above the breakeven level yields profit, while production below results in losses. Breakeven can be calculated using formulas that consider fixed costs, variable costs per unit, and selling price. It is useful for determining profit levels and the impact of price/cost changes, though it assumes linear costs and sales and may not reflect real-world complexities like unsold inventory or multi-product businesses.

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    © All Rights Reserved
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    23 views3 pages

    Business Note

    Uploaded by

    chinhour thav
    Breakeven analysis determines the minimum level of production or sales needed for a business to break even. It calculates the point where total revenue equals total costs. Production above the breakeven level yields profit, while production below results in losses. Breakeven can be calculated using formulas that consider fixed costs, variable costs per unit, and selling price. It is useful for determining profit levels and the impact of price/cost changes, though it assumes linear costs and sales and may not reflect real-world complexities like unsold inventory or multi-product businesses.

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    Breakeven analysis:

    Determination of the minimum level of production needed to break even


    Breakeven analysis is a means of calculating the level of output at which the
    business makes neither a profit nor a loss and at which total costs equal total
    revenue. It can also be used to calculate the amount of profit made at a specified
    level of output.
    Production of output above the breakeven level will yield a profit, while
    production levels below the breakeven level will produce a loss for the business.
    The breakeven level of output can be found by calculation or by using a graph.
    Contribution method
    The information required is total revenue (TR) (price × output sold); variable costs
    (VC) (either total or per unit); and fixed costs (FC).
    If the contribution method is used to calculate the breakeven level of output, the
    following formula is used:
    Contribution: the difference between revenue and variable costs, which can then be
    used as a contribution towards covering fixed costs.
    breakeven output = fixed costs
    contribution per unit (selling price per unit – variable costs per unit)
    For example, if the fixed costs for a product are $28,000, variable costs per unit
    are $10 and the selling price is $17 then the breakeven level of output will be:
    fixed costs = 28, 000 = 4, 000 units contribution 7 (17 – 10)
    Formulaic method
    Breakeven level of output can be calculated using the simple formula of TC = TR.
    Total costs = fixed costs + variable costs (variable costs per unit × quantity
    produced)
    Total revenue = price per unit × quantity sold. As the quantity is still
    unknown, we can call that Q.
    Using the same figures as for the contribution method the calculation would be:
    TR=TC
    17Q = 28,000 + 10Q 17Q − 10Q = 28,000
    7Q = 28,000 Q = 28,000
    7
    = 4,000
    This business will break even when 4,000 products are produced and sold.
    By diagram:

    Figure 2 Breakeven
    Figure 2 illustrates breakeven. When drawing a breakeven diagram, you need to:
    ● Give it a title, e.g. ‘Breakeven diagram for the Belltyre Bicycle Co. Ltd’.
    ● Make sure that you label the axes and each of the lines.
    ● Label the breakeven point.
    ● Mark the level of output actually achieved — this is known as the stated
    operating point or SOP.
    ● Mark the margin of safety (the difference between the achieved level of output
    and the breakeven level of output when the achieved level of output is higher than
    the breakeven level of output).
    ● Check your breakeven point by also using a calculation method.

    Margin of safety: the amount of output produced above the breakeven level of
    output.
    Calculation of the margin of safety
    Using the previous examples again, if the current level of output at the factory was
    6,500 units each year, then the margin of safety is 2,500 units. This means that if
    the sales of units fell by 1,000 units per annum, the business would still be
    profitable because the fall in sales is within the margin of safety.

    Uses of breakeven analysis


    ● To calculate the level of profit achieved at any given level of output.
    ● To calculate the level of output that would be required in order to achieve a
    specific level of profit.
    ● To calculate the impact of any changes to price and/or costs on the
    breakeven level of output

    The limitations of breakeven analysis


    ● It is assumed that all output is sold when in reality businesses often have
    unsold finished goods held in stock.
    ● The accuracy of breakeven calculations is dependent on the accuracy of the
    cost and revenue information. Inaccurate data will result in an inaccurate
    breakeven calculation.
    ● The cost and revenue lines are assumed to be linear when, in reality, they
    might not be. For example, a customer might receive a discount on the price
    if a large order is placed. In addition, as output increases, bulk purchases of
    materials might be made, so variable costs might reduce.
    ● Fixed costs can also increase over time due to increased production levels
    requiring the purchase of additional equipment.
    ● Breakeven analysis is only useful for one product. For a multi-product
    business breakeven analysis would be very complex to carry out.

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