Break Even Analysis

BREAK-­‐EVEN ANALYSIS

INTRODUCTION

• Every business manager should want to know how many products need to be sold or services provided to cover the total costs of the business. That is they need to know what it takes to break even.

• If a business cannot break-­‐even then decisions need to be made to correct the situation.

• Because break-­‐even is the point where total costs equal total revenue, anything sold above the break-­‐even point results in a profit being made; while anything sold below break-­‐even point results in a loss for the business.

TOTAL COSTS

• Total costs are made up of two main types of costs. These are:

-­‐ Fixed costs -­‐ Variable costs

Fixed Costs

• Fixed costs are so called because they do not vary with the level of activity or output within a given range e.g. For rent or land rates, it does not matter if you sell or produce no products or whether you sell or produce a number of products, you still pay the same amount.

Variable Costs

• Variable costs are so called because they vary in proportion to the level of activity or output. If output doubles, so does the variable cost i.e. direct labour and direct materials

BREAK-­‐EVEN POINT

• To calculate the break-­‐even in units arithmetically, we use the formula: