Break-even (Edexcel A Level Business)

Using Contribution to Calculate the Break Even Point

• 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

Margin of Safety

• 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

Interpretation of Break Even Charts

• 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

Limitations of Break Even Analysis

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