3.3 BREAK-EVEN ANALYSIS

DEFINITION

METHODS OF CALCULATING BREAK-EVEN

FURTHER USES OF BREAK-EVEN ANALYSIS

EVALUATION OF BREAK-EVEN ANALYSIS

BENEFITS

LIMITATIONS

Can make comparisons between different options by constructing new charts

The equation produces a precise break-even result

Provides useful guidelines to management

Use to assist managers when taking important decisions

Charts are easy to construct and interpret

No allowance made for stock levels ob the chart since it is assumed all units produced are sold

Cost and price data are often estimated and the actual data might vary from those that are used

Not all costs can be conveniently classified into fixed and direct costs at which welcoming the introduction of semi-variable cost

It is unlikely that the fixed costs will remain unchanged at different output levels

The assumptions of costs and revenues represented by straight line is unrealistic

The level of output at which total costs equal to total revenue

Can be used in determining a operations management decisions

Can be used in choosing between two locations for a new factory

Can be used in determining a marketing decision

Calculations involved;

Calculating target break-even revenue

Calculating target price

Calculating output to achieve target profit

(fixed cost + target profit) / contribution per unit

fixed cost / [1- (direct cost / price)]

(fixed costs/production level) + direct cost

Graphical Method

Formula Method

The Table Method

The Quantity sold, fixed costs, variable costs and total costs are tabulated

Revenue is determined when price is multiplied by the quantity

Profit later is being determined

The total costs line begins at the level of fixed costs but the follow the same gradient as variable costs

Sales revenue starts at the origin and increase at a constant rate

The variable cost line start from origin and increase at a constant rate

The point at which the total costs and sales revenue line cross is the break-even

The fixed cost line is horizontal showing that the cost are constant at all output level

The formula is - fixed costs / contribution per unit

Contribution per unit is the selling price of s product minus direct costs per unit

Break-even level of output can be calculated using contribution

Profit or loss can be predicted through total contribution

Total contribution is unit contribution multiply with the output

If total contribution of a product exceeds the fixed costs for the period, a profit has been made

If total contribution of a product is less than the fixed costs for the period, a loss has been made

Profit is shown by the positive difference between sales revenue and total costs

The y-axis is the costs and sales revenue meanwhile the x-axis is the units of output

Maximum profit is made at maximum output and is shown on the graph