# 3.3. Break-even Analysis

• Note:

• Total contribution = Total revenue – Total variable cost
• Contribution per unit = Price per unit – Variable cost per unit
• Break-even analysis
• BEQ is quantity when all are equal
• Break-even point
• Intersection of Total Cost and Total Revenue in a Break Even Chart
• Margin of safety
• Shows how much demand exceeds or fails to exceed BEQ
• Sales volume (Projected Demand) – BEQ
• Evaluate degree of risk based on demand for a product
• Can be expressed as a percentage of demand
• Target profit and revenue
• Can be used to calculate level of sales needed to attain a certain profit
• Ignores other factors that affect profit:
• Different pricing throughout time
• Level of demand is subject to change
• Profit depends on risk
• Innovation and luck – prediction aren’t always followed
• Must consider:
• Pricing strategies (penetration pricing, market skimming, etc.)
• Price elasticity
• Break-even is when total costs equal total revenue
• Helps to tell whether a good can be financially worthwhile and the level of profit a business is likely to earn
• Break-even quantity
• Minimum level of sales before the firm could break even
• When Total revenue  = Total fixed cost + [Total variable cost x Quantity]
• Break-even chart
• Title : Break Even Analysis for Company XYZ
• Label Axes:
• X-axis is output
• Y-axis is Revenue/Cost (label currency as well)
• Determine max. output and mark it, as well as revenue from this level of output
• If maximum isn’t given, make it twice the BEQ
• Determine BEQ and draw a vertical line at that point
• Mark the revenue gained from this quantity on the line (Break Even Point)
• Draw Total Fixed Cost line
• Draw Total Cost line
• starts at TFC at x=0, intersects the BEP
• Draw Total Revenue line
• starts at (0,0), intersects BEP

• Limitations
• Makes several assumptions:
• Fixed costs must be paid regardless of output
• Variable cost increases linearly
• Ignores economies of scale
• Sales revenue increases linearly
• Ignores discounts for large orders and price discrimination
• Assumes only one product is sold
• Every unit of output is sold
• Selling price is constant regardless of units sold
• Provides a static model (e.g. production costs can change)
• Depends on reliability of data
• Other factors can have an effect (e.g. competitors, staff motivation)
• Only suitable for single product firms

3.3. Break-even Analysis