Break-even (AQA GCSE Business)

Revision Note

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The Concept of Break-even

  • Break-even analysis is a financial tool used to determine the number of units a business must sell to reach a point where its revenue equals its expenses (no profit nor loss)

    • It helps businesses understand the minimum level of sales or output they need to achieve in order to cover all costs

    • This helps business managers make informed decisions about pricing and production volumes

Diagram: components of break-even analysis

The main components of break even analysis include variable costs, fixed costs, and revenue

Variable costs, fixed costs and sales revenue are all used in calculating the break-even point
 

  • Fixed costs are costs that do not change regardless of the level of production or sales

    • They remain the same at every level of output

      • E.g. rent, salaries and insurance

  • Variable costs are costs that vary with the level of production or sales

    • They increase in direct proportion with the level of output

    • E.g. raw materials, direct labour costs, packaging and shipping costs

  • Total costs are the sum of fixed costs and total variable costs at a particular level of output, calculated using the formula

Total space costs space equals space Fixed space costs space plus space Total space variable space costs

  • Revenue is the money gained from selling products, calculated using the formula

Sales space revenue space equals space Selling space price space cross times space Number space of space items space sold

Examiner Tip

You will not be expected to use the break even formula in your exam, but you may be asked to calculate revenue, costs or profit using given figures.

The Value of Break-even

  • 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 them an insight into the potential returns they can expect on investment

The Benefits of Break-even Analysis

Benefit

Explanation

Profitability assessment

  • 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

Pricing decisions

  • Break-even analysis helps managers set prices at a level that generates sufficient revenue to cover costs and generate a profit

Financial planning

  • Break-even analysis can help with target setting such as realistic sales targets and plans for necessary expenses

Performance monitoring

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

Decision making

  • It helps in weighing up the potential risks and rewards associated with different decisions

  • However, in common with other quantitative analysis tools, break-even analysis has some limitations

Diagram: limitations of break-even analysis

Break even analysis is based on forecasts, makes assumptions such as all output is sold and has limited use when business sell several products

Break even analysis is based on forecasts, makes assumptions such as all output is sold and has limited use when business sell several products

Examiner Tip

In Paper 2, some 'explain' questions are worth 4 marks, rather than 2 marks. In these questions, you must ensure that you use the business context to support your answer.

Example

Explain one reason why PiSkate Ltd should calculate the number of skateboards needed to break even. [4]

PiSkate can identify how many skateboards it needs to sell in order to cover all costs and start to make a profit [1]. It is currently able to produce 4,000 boards [1] and by calculating break-even it can see whether it can generate enough sales revenue from these to cover the cost of production [1] and, if so, how much profit they would make to reinvest in the business for its planned expansion [1].

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