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

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Written by: Lisa Eades

Reviewed by: Steve Vorster

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**

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.

Last updated: 29 October 2024

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