Break Even AnalysisBreak Even Analysis

Learning ObjectivesLearning Objectives

In today’s lesson you will earn about:In today’s lesson you will earn about:Re-cap of cost curvesRe-cap of cost curvesWhat is meant by revenue and how to What is meant by revenue and how to

calculate itcalculate itWhat a revenue curve looks like and how What a revenue curve looks like and how

to draw it to draw it Construction of a break even chartConstruction of a break even chart

CostsCosts

Costs

output

Fixed costs

Total costs

Variable costs

Total revenueTotal revenue

The value of the goods or services a The value of the goods or services a business sellsbusiness sells

Total Revenue = Price (of product) x Total Revenue = Price (of product) x quantity (sold)quantity (sold)

Example - if our previous example sells Example - if our previous example sells 10 of its product at £4 its revenue from this 10 of its product at £4 its revenue from this sale is;sale is;

Total revenue = 10x £4 = £40Total revenue = 10x £4 = £40

Total revenue and output (Firm X)Total revenue and output (Firm X)

Output (iPads)Output (iPads) Total Revenue(£)Total Revenue(£)

00 00

1010 4040

1515 6060

2020 8080

2525

3030

ExerciseExercise

In our previous example lets assume that the In our previous example lets assume that the firm we were looking at sells it’s product at £4firm we were looking at sells it’s product at £4

We’ll assume it sells all its output up to 30 unitsWe’ll assume it sells all its output up to 30 units Ie when it produces 10 units it sells all 10 at £4 Ie when it produces 10 units it sells all 10 at £4

so its revenue is £40so its revenue is £40 Now draw a new table showing costs, output Now draw a new table showing costs, output

and revenueand revenue Plot the firm’s revenue curve on a new graphPlot the firm’s revenue curve on a new graph

Revenue CurveRevenue CurveCosts/price

output

Total revenue

Break Even ChartBreak Even Chart

Now plot all the firms cost curves and Now plot all the firms cost curves and revenue curve on one big graphrevenue curve on one big graph

Use on side of A4 to do thisUse on side of A4 to do thisUse different colours for your lines if Use different colours for your lines if

possiblepossibleYou should have something that looks like You should have something that looks like

this: this:

Break Even ChartBreak Even Chart

Costs/prices

output

Fixed costs

Total costs

Total revenue

Break even output

Break even point

Profit( margin of safety)

loss

Explanation of Break Even Explanation of Break Even ChartChart

Shows the profit or loss made by the firm at Shows the profit or loss made by the firm at each level of productioneach level of production

The amount of profit is shown as the distance The amount of profit is shown as the distance between the total revenue and total cost curvesbetween the total revenue and total cost curves

Where total revenue = total cost is the break Where total revenue = total cost is the break even point I.e. neither profit or loss is madeeven point I.e. neither profit or loss is made

Above the break even point profit is madeAbove the break even point profit is made Below the break even point losses are madeBelow the break even point losses are made

Exercise Exercise

Caroline’s café 2 case studyCaroline’s café 2 case studyTasks 1,2,3,4Tasks 1,2,3,4

Decision making with break Decision making with break even even

Shows the effects of changes in costsShows the effects of changes in costsShows the effect of changes in Shows the effect of changes in

price/revenue price/revenue

limitationslimitations

Assumes all of the product is soldAssumes all of the product is soldUnexpected changes in costs can render Unexpected changes in costs can render

the chart obsolete the chart obsolete

Break Even FormulaBreak Even Formula

Break even = Break even = Fixed CostsFixed Costs

selling price – variable cost/unitselling price – variable cost/unit

ProfitProfit

Profit=Total revenue-total costsProfit=Total revenue-total costsEconomists see profit as the reward to Economists see profit as the reward to

entrepreneurs for risk taken in organising entrepreneurs for risk taken in organising the factors of productionthe factors of production

Land-rent, labour-wages, capital-interest, Land-rent, labour-wages, capital-interest, enterprise-profit enterprise-profit

Exercise Exercise

Page 360 It Makes You Think Questions Page 360 It Makes You Think Questions a, b,c,d,ea, b,c,d,e

Page 365 Heinemann textbook integrated Page 365 Heinemann textbook integrated activity Questions 1- 4activity Questions 1- 4

Question 1Question 1

Fixed CostsFixed Costs Van MOTVan MOT Javeds Salary Javeds Salary New photocopierNew photocopier Andrea’s salaryAndrea’s salary Fax machineFax machine Drivers salaryDrivers salary HeatingHeating LightingLighting New office carpetNew office carpet Tea bagsTea bags

Variable CostsVariable Costs PetrolPetrol Blank paperBlank paper Electricity for the pressElectricity for the press Ken’s wagesKen’s wages Telephone billTelephone bill Printing inkPrinting ink Distribution wagesDistribution wages StationaryStationary

Question 2Question 2

Break even = fixed costs/selling price - Break even = fixed costs/selling price - variable cost/unit variable cost/unit

Break even = 100/1.50-1.20 = 333.3 Break even = 100/1.50-1.20 = 333.3 i.e. 333.3 posters to break eveni.e. 333.3 posters to break evenBen has accepted the order for 500 Ben has accepted the order for 500

posters because he knows he will make a posters because he knows he will make a profit on every poster after 334 have been profit on every poster after 334 have been produced produced

Question 3Question 3

Break even = fixed costs/selling price - Break even = fixed costs/selling price - variable cost/unit variable cost/unit

New break even = 130/1.50-1.20 = 433.3New break even = 130/1.50-1.20 = 433.3Yes Ben should still accept the order of Yes Ben should still accept the order of

500 posters as he will make a profit on 500 posters as he will make a profit on every poster after 434 have been every poster after 434 have been produced produced

Question 4 Question 4

Break even = fixed costs/selling price - Break even = fixed costs/selling price - variable cost/unit variable cost/unit

(a) BE = 100/1.40-1.20 = 500 posters(a) BE = 100/1.40-1.20 = 500 posters (b) BE = 100/1.30-1.20 = 1000 posters(b) BE = 100/1.30-1.20 = 1000 posters

Ben should suggest selling price of £1.40 Ben should suggest selling price of £1.40 in order to make a profit ( at £1.30 he will in order to make a profit ( at £1.30 he will only break even) only break even)