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3.3: Break-Even Analysis (Break-Even Analysis – Further Uses (assist…
3.3: Break-Even Analysis
Calculating Break-Even – Methods
The Table Method
The Graphical Method (Break-Even Chart)
drawn showing :three: pieces of information
fixed costs (horizontal line/constant)
total costs (begins at level of fixed costs/follows same slope as variable costs)
sales revenue (starts at 0/increases at constant rate)
Margin of Safety
margin of safety
: the amount by which the output level exceeds the break-even level of output
indication of how much sales could fall without firm falling into loss
can be expressed as a percentage of break-even point
The Break-Even Formula
contribution per unit
: selling price of a product minus direct costs per unit
total contribution
: unit contribution × output
break-even level of output =
fixed costs / contribution per unit
Break-Even Analysis – Further Uses
assist managers in making key decisions
charts can be redrawn showing a potential new situation
Marketing Decision: impact of a price increase raises sales revenue line
Operations Management Decision: purchase of new equipment with low variable cost will lower variable costs line
Choose locations: different fixed & variable costs
Calculating Output to Achieve Target Profit
adapted version of the break-even formula
target profit level of output =
fixed costs + target profit / contribution per unit
Calculating Target Break-Even Revenue
break-even revenue
: the amount of revenue needed to cover both fixed and variable costs so that the business breaks even
break-even revenue =
fixed costs / 1 − (direct cost/price)
Calculating Target Price
break-even target price = [fixed costs / production level] + direct cost
Break-Even Analysis – Evaluation
Usefulness
charts easy to construct & interpret
provides guidelines to management on break-even points, safety margins & profit/loss levels
compare different options by constructing new charts
precise break-even result by equation
aid manager on important decision making
Limitations
assumption of costs & revenues being a straight line is unrealistic
not all costs can be classified into fixed or direct costs
semi-variable makes technique more complicated
no allowance made for stock levels
break-even
: the level of output at which total costs equal total revenue
easier to make important production and marketing decisions
at break-even level of output and sales, profit is zero
total costs = total revenue
Cecilia Martínez A01197738