BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

Breakeven Revision Notes

A business will use breakeven to work out what volume of sales it needs to cover the

production costs.

The contribution tells us how much each product made contributes towards the fixed

costs. We work out the contribution of a product by using the following formula:

contribution = selling price – variable costs per unit

For example, if a book sells for £12 and the variable cost for each book was £7, the contribution would be £5, this is £5 towards the fixed costs. If the fixed costs of the business were £30,000 then we would know that 6,000 books needed to be sold in order

to break even.

The margin of safety of a product shows us the difference between the estimated breakeven sales production and number of planned sales (or maximum sales value). Using the same example of the book, if the business reckons they are able to sell 7,500 units, and the breakeven sales production was 6,000 – the margin of safety would have been 1,500. This means that the business would be able to sell 1,500 products less than they had planned before being in danger of making a loss.

Calculating Breakeven

There are a number of ways to do this. We can use a table, graph or a formula.

If we want to use the graph, we need first to do the table. Take this business as an example:

The Daily Waffle is a newspaper.

Each newspaper is sold for 85p
The variable costs per newspaper is 30p
The fixed costs are £200,000

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

To draw up the table, we need the following columns:

N^o of Units	Variable Costs	Fixed Costs	Total Costs	Sales Revenue

To fill in the table, we pick a sensible range of data, as shown in the next table:

Multiply the number of units by the variable cost per unit to calculate the variable costs for each row
Leave the fixed costs as they are, as they do not change with output
Multiply the number of units by the selling price to calculate sales revenue
Add together the fixed costs and variable costs to calculate total costs
To calculate the profit/loss, take total costs away from sales revenue

N^o of Units	Variable Costs	Fixed Costs	Total Costs	Sales Revenue
0	£0	£200,000	£200,000	£0
100,000	£30,000	£200,000	£230,000	£85,000
200,000	£60,000	£200,000	£260,000	£170,000
300,000	£90,000	£200,000	£290,000	£255,000
400,000	£120,000	£200,000	£320,000	£340,000
500,000	£150,000	£200,000	£350,000	£425,000
600,000	£180,000	£200,000	£380,000	£510,000

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

Now we come to drawing the graph:

Step 1: Draw the axis. Money (£) always goes up the y axis, and units along the x axis
Step 2: Plot the fixed costs. In this case £200,000

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

units

100,000

200,000

300,000

400,000

500,000

100,000

200,000

300,000

400,000

500,000

600,000

fixed costs

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

units

£

100,000

200,000

300,000

400,000

500,000

100,000

200,000

300,000

400,000

500,000

600,000

0

0

fixed costs

total costs
tep 3: Now we plot the points for the total costs and join them up

Note: At this point check you have your values right, and assure that the total costs begin at 0 units at the base rate of the fixed costs

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

units

100,000

200,000

300,000

400,000

500,000

100,000

200,000

300,000

400,000

500,000

600,000

fixed costs

total costs

sales revenue

tep 4: Plot the points for revenue and connect them. These points should begin at £0

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

Step 5: Find the point where the two lines (sales revenue and total costs) meet

Step 6: Draw a line to each axis to show the break-even point and break even sales

BREAKEVEN REVISION NOTES A BUSINESS WILL USE BREAKEVEN

units

100,000

200,000

300,000

400,000

500,000

100,000

200,000

300,000

400,000

500,000

600,000

fixed costs

total costs

sales revenue

break-even point

break-even sales production

production

The breakeven point shows us the point where the two values – the total costs and the sales revenue income – are equal
The breakeven sales production shows us this also, but gives us the exact number of units estimated to be the breakeven production point. This is not entirely accurate, as it is just an estimate, but we can compare it to the value we arrive at when calculating breakeven using the formula…

If you want to use a formula to work out the breakeven of a product, we use this:

breakeven =

fixed costs

contribution

…when:

contribution = selling price per unit – variable costs per unit

So using the newspaper example, the contribution will be the selling price minus the variable costs: 85p – 30p = 55p. We now know that each unit sold contributes 55p towards the fixed costs.

The fixed costs are £200,000. If we divide 55p by this amount (200,000 ÷ 0.55) we arrive at 363636, which we can round to about 365000. Comparing our value of 365,000 to the value from the graph which appears to be about 375,000 – we can see that they are not too far apart.

The Dangers of Breakeven

Breakeven is not entirely accurate and is not as useful as it may sometimes seem. The main limitations of breakeven charts are:

They do not take into account possible changes in costs over the time period, e.g. economies of scale or increase in production costs/materials
They do not allow for changes in the selling price, e.g. they would not take note of price reductions and special offers
The analysis of the breakeven is only as good as the quality of the information
They do not allow for changes in the market effects, e.g. if a new competitor to the business is introduced to the market in the time period

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