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O LevelBusinessCambridge (CIE)Business StudiesRevision Notes4. Operations Management4.2 Costs, Break-even & Production ScaleBreak-even Calculations

Break-even Calculations (Cambridge (CIE) O Level Business Studies)

Revision Note

Danielle Maguire

Written by: Danielle Maguire

Reviewed by: Steve Vorster

Calculating Break-Even

  • The break-even point can be calculated using one of two formulas

    • The first calculates the number of units which need to be sold to break-even

space Breakeven space space point space in space units space equals space fraction numerator Fixed space cost over denominator open parentheses Selling space price space minus space variable space cost close parentheses end fraction

  • The second calculates the value of the costs/revenue at which point the firm breaks even

     space Break minus even space point space value space equals space space break minus even space point space in space units space cross times space selling space price

Worked Example

Mięsisty Burgers has the following financial information for the month of May.

 

€ May

Raw materials for each burger

2.10

Packaging for each burger

0.20

Fixed costs

 1 730

Selling price of each burger

4.95

(a) Using the information in the table, calculate the level of output required to break even in May. You are advised to show your workings (3 marks)

Step 1 - Calculate the variable costs per burger

Variable space cost space per space burger space equals space Raw space materials space plus space Packaging Variable space cost space per space burger space equals space € 2.10 space plus space € 0.20 space equals space € 2.30 

 (1 mark)

Step 2 - Substitute the values into the breakeven formula

  Break space even space point space in space units space equals space fraction numerator Fixed space Cost over denominator stretchy left parenthesis Selling space price space minus space variable space cost stretchy right parenthesis end fraction Break space even space point space in space units space equals space fraction numerator 1 comma 730 over denominator stretchy left parenthesis 4.95 space minus space 2.30 stretchy right parenthesis end fraction Break space even space point space in space units space equals space fraction numerator 1 comma 730 over denominator stretchy left parenthesis 2.65 stretchy right parenthesis end fraction Break space even space point space in space units space equals space fraction numerator 1 comma 730 over denominator stretchy left parenthesis 2.65 stretchy right parenthesis end fraction Break space even space point space in space units space equals space 653 space    

 (2 marks)

Step 3 - Round to the nearest unit

     653 burgers need to be sold to break even in May (2 marks for a correct answer)

Examiner Tips and Tricks

Always round up the break even point to the nearest whole unit

The Margin of Safety

  • The margin of safety is the amount by which the number of units sold is greater than the break even point

  • The margin of safety provides useful information to a firm on how many sales they could lose before they start making a loss

  • The margin of safety can be calculated using the following formula

Margin space of space safety space equals quantity space of space sales space minus space breakeven space level space of space sales 

  • Businesses want their margin of safety to be as large as possible

    • This means that if demand for their products drops unexpectedly, the business will continue to make a profit

Worked Example

Figure 1 shows the weekly break-even diagram for the Yorkshire Rare Breed Sausage Company. 

Figure 1: Output, Costs & Revenues of the Yorkshire Rare Breed Sausage Company
Figure 1: Output, Costs & Revenues of the Yorkshire Rare Breed Sausage Company

Using Figure 1 above, calculate the weekly margin of safety. Show your workings and the formula used. (3)

Step 1 - Write the formula down

   begin mathsize 14px style Margin space of space safety space equals space quantity space of space sales space minus space breakeven space level space of space sales end style (1 mark)

Step 2 - Read from the chart and substitute values into the formula

   Margin space of space safety space equals quantity space of space sales space minus space breakeven space level space of space sales Margin space of space safety space equals space 4 comma 000 space minus space 2 comma 500 Margin space of space safety space equals 1 comma 500 space sausages

(1 mark for any correct working; 3 marks for the correct answer)

Examiner Tips and Tricks

Use a ruler to help you to read break even charts accurately.

Using Break-even Analysis to make Decisions

  • Break-even calculations are a useful tool for a business to use in deciding how much to produce and calculating estimated levels of profit

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

    • Knowing when the business will break-even or how much profit it is expected to make may attract or deter shareholders from investing in the business

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

    • It helps the business to assess the costs and expected returns of new projects and expansion plans

      • By considering the break-even point, businesses can assess the potential risks and rewards associated with different decisions

Examples of Using Break-even in Decision-making

Use of Break-even

Explanation

Assessing profit or loss

  • 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

Managing costs

  • 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

Redrawing the graph with changes

  • Break-even analysis allows businesses to see 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

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    Author
    Reviewer
    Danielle Maguire

    Author: Danielle Maguire

    Expertise: Business Content Creator

    Danielle is an experienced Business and Economics teacher who has taught GCSE, A-Level, BTEC and IB for 15 years. Danielle's career has taken her from across various parts of the UK including Liverpool and Yorkshire, along with teaching at a renowned international school in Dubai for 3 years. Danielle loves to engage students with real life examples and creative resources which allow students to put topics in a context they understand.

    Steve Vorster

    Author: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.