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Break Even

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16 views26 pages

Break Even

Uploaded by

afnanmirza106
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Break-Even Analysis

Break-Even Analysis

Break-even analysis in economics, business, and cost accounting refers to the point at which total costs and total revenue are equal. A break-even point analysis is used to determine the number of units or dollars of revenue needed to cover total costs (fixed and
variable costs).
Sales Analysis Overview

• X-axis: Units sold, dollar amount.


• Y-axis: Total fixed costs.
• Red line: $100,000 fixed costs.
• Blue line: Revenue per unit sold.
• Yellow line: Total costs (fixed and variable).
Q= 0 units VC= $0
FC=$100,000
Q= 10,000 units VC=$20,000
FC=$100,000
The break even point =10,000 units.
TR= 10,000 x $12 = $120,000 and
TC= 10,000 x 2 = $20,000 (VC) +$100,000 (FC)

Profit when Revenue > Total Variable Cost +


Total Fixed Cost
Break-even point when Revenue = Total
Variable Cost + Total Fixed Cost
Loss when Revenue < Total Variable Cost + Total
Fixed Cost
What-If Analysis

It helps in a Financial Sensitivity


Analysis, also known as a What-If
analysis or a What-If simulation
exercise, is most commonly used by
financial analysts to predict the
outcome of a specific action when
performed under certain conditions.
For example, sensitivity analysis can
be used to study the effect of a
change in interest rates on bond
prices if the interest rates increased
by 1%. The “What-If” question
would be: “What would happen to
the price of a bond If interest rates
went up by 1%?”. This question can
be answered with sensitivity
analysis.
If interest rates increased by 1%, the price of a
bond would typically decrease. This inverse
relationship between bond prices and interest
rates is a fundamental principle in bond
valuation. When interest rates rise, newly
issued bonds offer higher yields, making
existing bonds with lower yields less
attractive. As a result, the prices of existing
bonds fall to make their yields more
competitive with the higher rates available in
the market.
A bond face value = $1,000
Coupon rate = 5% (annual coupon payment of
$50). This bond’s maturity =5 years.
Current interest rate = 4%.
Coupon rate 5% > Market rate (4%).
The price of bond might = $1,050.
However, if market interest rates increase by 1%
to 5%, new bonds issued will offer a higher yield
(5%) compared to your bond's 5% coupon rate.
Investors would prefer these new bonds over
yours, causing the price of your bond to
decrease.
Using bond valuation formulas such as
present value calculations, you could find
that the price of your bond might drop to,
for example, $950 in response to the 1%
increase in interest rates.
So, in this example, a 1% increase in
interest rates led to a $100 decrease in the
price of the bond.
• BEP: The point where total revenues equal total
costs, indicating neither profit nor loss.
• Used to determine sales or production volume
required to cover all costs.
• Crucial for assessing business viability.
Present Value (PV): Current value of future money,
discounted at an appropriate interest rate.
• Used to determine the value of investments, loans,
annuities, etc.
Future Value (FV): Future value of an investment or
asset at a specified future date, based on compound
interest.
• Important for assessing investment growth potential
and planning future financial goals.
Example handmade crafts
Initial investment =$5,000
Expected profit= $10 per unit
Fixed costs= $500 per month.
To cover the $500 fixed costs, you need to sell:

BEP=Fixed Costs/Profit per Item or


BEP=Fixed Costs/Selling price - Average variable
cost
BEP=50 items
Factors that Increase a Company’s Break-
Even Point
• Increase in customer sales: Increased demand
leads to higher production, raising the break-even
point to cover extra expenses.
• Increase in production costs: Variable costs like
raw materials increase, causing the break-even
point to rise. Other costs include warehouse rent,
employee salaries, and utility rates.
• Equipment repair: Equipment failures increase
the break-even point as the target number of
units is not produced within the desired time
frame.
• Reducing the break-even point: Raise
product prices to generate higher
profits.
• Outsourcing: Outsourcing can reduce
manufacturing costs when production
volume increases.
• Understanding the break-even
number of units is crucial for setting
sales targets and achieving financial
goals.
Break-Even Point Factors and Reduction
Strategies
• Increase in customer sales: Increased
customer sales lead to higher demand,
increasing the break-even point to cover
extra expenses.
• Increase in production costs: Variable
costs like raw materials increase, leading to
a higher break-even point. Other costs
include warehouse rent, employee salaries,
and utility rates.
• Equipment repair: Equipment failures increase
the break-even point as the target number of
units is not produced within the desired time
frame.
• Reducing the break-even point: Raise product
prices to generate higher profits.
• Outsourcing: Outsourcing can reduce
manufacturing costs when production volume
increases.
• Understanding the break-even number of
units is crucial for determining sales targets and
achieving financial goals.
Let’s say Company A sells premium water
bottles. Here are the details:
Fixed Costs: $100,000 (includes property taxes,
lease, and executive salaries)
Variable Cost per Water Bottle: $2
Selling Price per Water Bottle: $12
Break-Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost Per Unit)
Break-Even Quantity = $100,000 / ($12 – $2) =
10,000 water bottles
Therefore, Company A needs to sell 10,000
water bottles to break even
Break Even Analysis Varies Among
Industries
Typical variable and fixed costs differ widely
among industries. This is why comparison of
break-even points is generally most
meaningful among companies within the
same industry. The definition of a 'high' or
'low' break-even point should be made
within this context.
Example of Break Even Analysis
In this break even analysis sample, Restaurant ABC only sells
pepperoni pizza. Its variable expenses for each pizza include:

Flour: $0.50

Yeast: $0.05

Water: $0.01

Cheese: $3.00

Pepperoni: $2.00
Adding all of these costs together, we determine that it has $5.56 in
variable costs per pizza. Based on the total variable expenses per
pizza, Restaurant ABC must price its pizzas at $5.56 or higher to
cover those costs.
The fixed expenses per month include:
Labor: $1,500
Rent: $3,000
Insurance: $200
Advertising: $500
Utilities: $450
In total, Restaurant ABC's fixed costs are $5,650.
Let’s say that each pizza is sold for $10.00. Therefore the
contribution margin is $4.44 ($10.00 - $5.56).
To determine the number of pizzas (or units) Restaurant ABC
needs to sell, take its fixed costs and divide them by the
contribution margin: $5,650 ÷ $4.44 = 1,272.5
This means the restaurant needs to sell at least 1,272.53
pizzas (rounded up to 1,273 whole pizzas), to cover its
monthly fixed costs. Or, the restaurant needs to have at least
$12,730 in sales (1,272.5 x $10) to reach the BEP.
Stock Market Breakeven Points
Assume an investor buys Microsoft stock (MSFT)
at $110. That is now their breakeven point on the
trade. If the price moves above $110, the investor
is making money. If the stock drops below $110,
they are losing money. If the price stays right at
$110, they are at the BEP because they are not
making or losing anything. Options can help
investors who are holding a losing stock position
using the option repair strategy.
Break-Even Point Factors and Reduction
Strategies
• Increase in customer sales: Increased customer
sales lead to higher demand, increasing the
break-even point to cover extra expenses.
• Increase in production costs: Variable costs like
raw materials increase, leading to a higher
break-even point. Other costs include warehouse
rent, employee salaries, and utility rates.
• Equipment repair: Equipment failures increase
the break-even point as the target number of
units is not produced within the desired time
frame.
• Reducing the break-even point: Raise product
prices to generate higher profits.
• Outsourcing: Outsourcing can reduce
manufacturing costs when production volume
increases.
• Understanding the break-even number of units
is crucial for determining sales targets and
achieving financial goals.

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