Changes to & Limitations of Break-Even (DP IB Business Management)

Revision Note

Flashcards

Changes to Break Even

  • Changing any of the variables of break-even (selling price, variable cost per unit or total fixed costs) changes the break-even point and level of profit it can expect to achieve

Changes in Variables and the Break Even Point

Increased Selling Price

  • An increase in the selling price reduces the break-even point

hAn increase in the selling price means that fewer units need to be sold to breakeven
  • An increase in the selling price increases revenue at each level of output from R1 to R2

  • The break-even point falls from BEP1 to BEP2

  • Profit on each unit of output greater than the break-even point is increased

Decreased Selling Price

  • A decrease in the selling price increases the break-even point

A decrease in the selling price means that more units have to be sold for the firm to breakeven
  • A decrease in the selling price reduces revenue at each level of output from R1 to R2

  • The break-even point rises from BEP1 to BEP2

  • Profit on each unit of output greater than the break-even point is decreased

Increased Variable Costs

  • An increase in variable costs increases the break-even point

An increase in variable costs increases the breakeven point of a firm
  • An increase in variable costs increases total costs at each level of output from TC1 to TC2

  • The break-even point increases from BEP1 to BEP2

  • Profit on each unit of output greater than the break-even point is decreased

Decreased Variable Costs

  • A decrease in variable costs decreases the break-even point

A decrease in variable costs lowers the breakeven point of a firm
  • A decrease in variable costs decreases total costs at each level of output from TC1 to TC2

  • The break-even point falls from BEP1 to BEP2

  • Profit on each unit of output greater than the break-even point is increased

Increased Fixed Costs

  • An increase in fixed costs increases the break-even point

An increase in fixed costs raises the number of units a firm needs to sell in order to breakeven
  • An increase in fixed costs increases total costs at each level of output from TC1 to TC2

  • The break-even point increases from BEP1 to BEP2

  • Profit on each unit of output greater than the break-even point is decreased

Decreased Fixed Costs

  • A decrease in fixed costs decreases the break-even point

A decreased level of fixed costs means that the firm has to sell fewer units in order to breakeven
  • A decrease in fixed costs reduces total costs at each level of output from TC1 to TC2

  • The break-even point falls from BEP1 to BEP2

  • Profit on each unit of output greater than the break-even point is increased

Benefits & Limitations of Break-even Analysis

  • Break-even analysis provides valuable insights into the financial viability and performance of a business

  • It is particularly useful for communicating with stakeholders, including investors or lenders

    • It demonstrates the financial viability of the business and gives an insight into potential returns on investment

The Benefits of Break-even Analysis

Use of Break Even

Explanation

Profitability assessment

  • It allows businesses to assess their profitability by determining the minimum level of sales needed to cover all costs

  • It helps identify the level of sales required to avoid losses and provides a target for achieving profits

Cost control

  • Break-even analysis helps in identifying fixed and variable costs and their impact on the business

  • By understanding the cost structure businesses can evaluate their spending patterns and reduce unnecessary expenses

Pricing decisions

  • Break-even analysis provides insights into pricing decisions by helping businesses determine the minimum price required to cover costs and achieve the desired level of profit

  • It ensures that prices are set at a level that generates sufficient revenue to meet expenses and generate profits

Financial planning

  • Break-even analysis assists in financial planning by providing a reference point for target setting such as realistic sales targets and plans for necessary expenses

Sensitivity analysis

  • Break-even analysis allows businesses to conduct sensitivity analysis by evaluating the impact of changes in variables such as costs, prices, and sales volumes on the break-even point

  • This helps in understanding the potential risks and uncertainties such as a new competitor entering the market or suppliers increasing prices

Performance monitoring

  • Break-even analysis serves as a benchmark for monitoring business performance over time

  • By comparing actual sales and costs against the break-even point businesses can assess their financial health and track progress

Decision making

  • Break-even analysis provides a basis for informed decision making 

  • It helps in evaluating the feasibility of new projects and expansion plans - by considering the break-even point, businesses can assess the potential risks and rewards associated with different decisions

  • In common with other quantitative analysis tools, break even analysis has some limitations

Diagram: limitations of break even analysis

The limitations of break even analysis
The limitations of break even analysis

Examiner Tip

When evaluating break-even analysis, ensure that you explain why it has an important internal planning role, but don’t forget that it has a significant external role too.

Break-even analysis should be included in a business plan when a business is trying to secure external finance. Businesses looking to borrow money or attract investors seeking to manage their risk should take care to model the break-even point, margin of safety and level of profit (or loss) at different levels of output and be prepared to be scrutinised on the figures.

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