Break-even (Edexcel A Level Business)

• The contribution value is used to calculate the Break Even Point
  
  
• The Break Even Point is where a total revenue earned for a product is exactly equal to its total costs and where the business is making neither a profit nor a loss
   

• The break even point is expressed as several units (e.g. the number of scented candles)
  
  
• Identifying the break even point allows a business to understand how many items it needs to produce and sell to cover all costs before it starts to make a profit
  
  • Each subsequent unit sold past this point will generate profit for the business

• The margin of safety is the difference between the actual level of output of a business and its break even level of output
  
  
• The margin of safety can be calculated using the following formula
  
  

• A break even chart is a visual representation of the break even point and is used to identify the following
  • Fixed costs, total costs and revenue over a range of output
  • The break even point - where total costs are equal to revenue
  • Profit or loss made at each level of output
  • The margin of safety
     

The break even chart for A2B Limited shows that at 324 units the total revenue = the total costs
  

Diagram analysis 

• Fixed costs do not change as output increases
  • A2B's fixed costs are £8,000 and these do not change whether the business produces 0 units or 500 units
     
• Total costs are made up of fixed and variable costs
  • At 0 units of output, they are made up exclusively of fixed costs
  • At 500 units the total variable costs equate to £11,800
  • This line slopes upwards because total variable costs increase as output increases
     
• The revenue line also slopes upwards
  • At 0 units of output, the revenue is £0
  • At 500 units the total revenue equates to £11,800
  • Revenue will increase with the output
  • The line will slope more steeply than the total costs and will cross the total costs line at some point
     
• The point at which the total costs and the revenue lines cross is the break even point
  • The break even level of output for A2B is 324 units
    
    
• The margin of safety can be identified as the difference on the x-axis between the actual level of output (in this case 450 units) and the break even point
  
  
• The profit made at a specific level of output can be identified as the space between the revenue and total costs lines
  • In this instance the profit made at 450 units of output is £14,400 - £11,250 = £3,150

The limitations of break even analysis
 

• The limitations of break even analysis can be used to evaluate the usefulness of this tool for a start up or growing business