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Break-even Analysis

 

Break-even analysis allows firms to identify the minimum level of sales needed to make a profit.  It is possible to identify the break-even point on a break-even chart.

 

 

Up to the break-even output the firm will operate at a loss and at higher levels the firm will receive a profit.  The difference between the break-even and present outputs is known as the margin of safety, in other words the quantity sold can fall by that amount before the firm will start to lose money.

 

Calculating break-even output is a relatively simple task:

            =  fixed costs contribution per unit

 

Break-even analysis is an excellent tool to analyse a business.  It is cheap to carry out and it can show the profits/losses at varying levels of output.  Often a new firm will have to present a break-even analysis in order to secure finance.  It does have some limitations:

  • It assumes that all of the output is sold; often not all output will be sold.
  • It assumes that all of the output is old at the same price; often a firm will have to lower its price in order to increase its sales.
  • It assumes that variable costs are constant, economies of scale may in fact reduce them as output grows.
  • It is only as useful as the underlying data, if information is out of date then the analysis will be flawed.

 

Shifts in the Break-Even Point

There are a number of factors, both internal and external that will lead to a change in the break-even point.

 

INTERNAL FACTORS

Employing extra sales staff will increase the fixed costs and therefore the totals costs, thereby raising the break-even point.

 

 


A price increase will cause the total revenue to rise at each level of output, lowering the break-even point.

 

 

Introducing a greater degree of automisation would increase fixed costs, whilst variable costs would fall; therefore the effect on the break-even point would be uncertain.  

You can vary different factors in a break even simulation by Biz/ed.

EXTERNAL FACTORS

If a recession occurred the break-even point would be unaffected, however demand for the product would fall, thereby reducing the margin of safety.

 

If a price war broke out, the revenue would be reduced at each level of output, causing the break-even point to rise.

 

 

Inflation would push up variable cost, causing the break-even point to rise.

 

Further Reading

Eurotunnel may miss break-even point
Break even simulation by Biz/ed
Break even analysis by Business Town

 

 

 

E-mail Steve Margetts