Breakeven

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Break-even
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Break-even is the output level where total costs
equal total revenue.

• Break-even analysis is a technique used to
  estimate, on purely financial costs and revenue
  basis, the number of units which must be produced
  and sold for a project to break-even.

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• With this simple technique, a manager can
  calculate the effect of different marketing
  strategies and different pricing strategies on
  the business.

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• The break-even point is where total costs equal
  total revenue in other words, no profit is being
  made and no loss is being incurred.
• The break-even point gives a business an
  initial target at which to aim.

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• Break-even does not specify a time that it will
  take to reach this level. This will depend on how
  quickly sales are generated.

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• In some cases it can be many years before a
  firm would reach its break-even sales level.
• A bank or other investor will almost certainly
  want to see break-even information.

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To work out break-even we need to know various
bits of information

• The price you are charging
• The variable costs (direct costs) of each unit -
  these are the costs of raw materials, labour and
  so on that can be directly attributed to each
  unit.
• The fixed costs (or indirect costs/overheads) -
  these are the costs that stay the same whatever
  the level of output and will be things like rent,
  marketing costs, admin costs and so on.
• Once we have this information, we can work
  out the break-even level of output. Let's look at
  an example

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Worked example

• Dragon Shirts Ltd, based in Bridgend
  manufacturing mens shirts. It has a factory
  which has a maximum output of 70,000 shirts a
  year.

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Step 1

• Selling price per sheet - 20
• Variable cost per shirt - 10
• Total fixed cost per year - 400,000

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• Choose an appropriate scale for your diagram

Maximum Quantity70,000 units
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Step 2

• Draw the fixed cost line on the graph.

Fixed costs
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Step 3 Add the Total Cost line

• Total costs are fixed costs plus variable costs.
• 400,000 (70,000 x 10) 1,100,000

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Step 3
Fixed costs Variable costs
400,000
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Step 4

• Add the total revenue curve to the graph.
• Total revenue for 70,000 shirts.
• 70,000 x 20 1,400,000

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• Maximum revenue is
• 20 X 70,000 (shirts)
• 1,400,000

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Step 5

• Identify the break-even point where the total
  revenue line crosses the total cost line.
• Identify the margin of safety

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Calculating break-even point

• Break-even occurs when fixed costs and variable
  costs are covered by the revenue from units sold.
  This depends on how much is made on each unit sold

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• Shirts are sold for 20. The variable costs
  are 10.
• 20 - 10 10
• Each shirt sold will provide 10 which can be
  used to cover fixed costs. Once fixed costs are
  covered each sale will contribute 10 towards
  profit.

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The equation

• Total Fixed costs Break-even point
• Contribution per unit
• 400,000
  40,000 shirts
• 10