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

An Introduction to Break-even

• Break-even analysis is a financial tool used to determine the number of units a business must sell to reach the point where the business 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 to make informed decisions about pricing and production volumes

• The break-even point is the number of units that need to be sold for total costs to equal the sales revenue

Diagram: the elements of a break-even analysis

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

  • E.g. rent, salaries and insurance

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

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

• Sales revenue is the money gained from selling products/service and is calculated as follows

  • Sales revenue = number of items sold x selling price

Constructing a Break-even Chart

• Break-even charts are graphs which show how costs and revenues of a business change with sales

  • It identifies the number of units a business must sell in order to break-even

• In order to construct a break-even chart the business needs to know the estimated fixed costs, variable costs and sales revenue

Break-even Table of Costs and Revenue for Tee-Crazy Ltd

• Tee Crazy Ltd has the following estimates

  •  Fixed costs are $8,800 per year

  • The variable costs of each t-shirt is $4

  • Each t-shirt is sold for a price of $10

  • The factory can produce a maximum output of 3000 t-shirts per year 

Diagram: how to construct a break-even chart

• Production output below the break-even point results in the business making a loss

  • Production output above the break-even point results in a profit

Interpreting a Break-even Chart

• A break even chart is a visual representation of the break-even point and is used to identify several key metrics

  • The break-even point

  • The margin of safety

  • The expected profit or loss 

Diagram of a break-even chart

Diagram analysis 

• Fixed costs do not change as output increases

  • A2B's fixed costs are £8,000 and these do not change whether the business produces 0 units or 500 units

• Total costs are made up of fixed and variable costs

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

  • At 500 units the total variable costs equate to £11,800

  • This line slopes upwards because total variable costs increase as output increases

• The revenue line also slopes upwards

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

  • At 500 units the total revenue equates to £11,800

  • Revenue will increase with the 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 for A2B is 324 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 (300 units). The margin of safety is 150 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 - £11,250 = £3,150