Break-even Charts (Edexcel IGCSE Business)

Elements of Break-even Charts

• A break-even chart is a visual representation of the break-even point in a graph
  
  

• Three lines are plotted on a graph with an x-axis labelled units and a y axis labelled costs/revenues

  • Fixed costs

  • Total costs

  • Revenue
    
    

• The break-even point is the output level at which the revenue and total costs line cross
  
  

• The break-even chart can also be used to identify the following
  

  • Profit or loss at different levels of output

    • Profit is achieved when revenue is greater than total costs

    • A loss occurs when total costs are greater than revenue
      
      

  • The margin of safety, which is the difference between the actual level of output and the break-even point
    

Interpreting Break-even Charts

• The elements can be identified in the break-even chart below

  • The selling price is £32 per unit

  • Variable costs are £7.60 per unit

  • Fixed costs are £8,000
    

Diagram: Break-even Chart with Key Elements
  

The break-even chart shows the break-even point, profit at a given level of output and the margin of safety  

Diagram analysis 

• Fixed costs do not change as output increases

  • Fixed costs are £8,000 and these do not change whether the business produces 0 units or 500 units

  • It is therefore represented by a horizontal line at £8,000 for all levels of output
     

• Total costs are made up of fixed and variable costs

Fixed, Variable and Total Costs at Different Levels of Output

• At 0 units of output, total costs are made up exclusively of fixed costs

• At 500 units, the total costs are £11,800

• In the chart, the total costs line slopes upwards because total variable costs increase as output increases
   

• Revenue is the quantity sold x selling price

Revenue at Different Levels of Output

• The revenue line also slopes upwards

  • At 0 units of output, the revenue is £0

  • At 500 units the total revenue equates to £16,000

  • Revenue increases with 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 is 328 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 margin of safety is 450 - 328 = 122 units
    
    

• 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 - £11,420 = £2,980

The Impact of Changes in Revenue & Costs

• Changing in the selling price, variable cost per unit or total fixed costs affects the break-even point and level of profit or loss
   

How the Break-even Point & Level of Profit is Affected by Changes in Variables

Increased Selling Price	Decreased Selling Price
An increase in the selling price reduces the break-even point   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	A decrease in the selling price increases the break-even point   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	Decreased Variable Costs
An increase in variable costs increases the break-even point   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	A decrease in variable costs decreases the break-even point   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	Decreased Fixed Costs
An increase in fixed costs increases the break-even point 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	A decrease in fixed costs decreases the break-even point 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

Limitations of Break-even Charts

• Whilst they provide an accessible way to understand costs, revenues and break-even there are some limitations of using break-even charts to support decision making

1. Costs do not always increase in direct proportion to units sold

• Businesses may be able to negotiate bulk-buying discounts that reduce variable costs per unit at high levels of output

• Fixed costs could increase significantly at higher levels of output as more staff or equipment may be required

2. Revenue does not always increase in direct proportion to units sold

• Buyers may demand discounts for placing large orders, which will reduce the selling price per unit

3. Cost data is often an estimate 

• If break-even charts are used for forecasting, future cost estimates are used

• The reliability of these estimates depends on the skills and experience of buyers and financial planners

4. Some output may remain unsold

• The model assumes that all units produced are sold

• In reality, businesses keep some stock as a buffer to meet demand at a later date

• Unsold stock may be sold at a lower price to reduce storage costs or raise cash