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Chapter 24 Breakeven Point

Break-even analysis is a financial tool that determines the point at which a business's revenues equal its total costs, known as the break-even point (BEP). It helps businesses identify minimum sales volume needed to cover costs, assists in pricing decisions, and analyzes cost structure impacts on profitability. Key data required includes fixed and variable costs, sales revenue, and historical or forecasted sales data.

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12 views33 pages

Chapter 24 Breakeven Point

Break-even analysis is a financial tool that determines the point at which a business's revenues equal its total costs, known as the break-even point (BEP). It helps businesses identify minimum sales volume needed to cover costs, assists in pricing decisions, and analyzes cost structure impacts on profitability. Key data required includes fixed and variable costs, sales revenue, and historical or forecasted sales data.

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naimamanzoorofficial
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Break-Even and Cost-Volume-

Profit Analysis

Chapter 24
Break-even Analysis
Break-even Analysis is a financial calculation used to determine the
point at which a business’s revenues exactly equal its total costs—
meaning there is no profit and no loss. This point is known as the
break-even point (BEP).
Key Aspects:
• It helps businesses understand the minimum sales volume
needed to cover costs.
• It separates fixed costs (e.g., rent, salaries) and variable costs
(e.g., materials, commissions).
• It is commonly used in pricing, financial planning, and decision-
making.
Break-even Formula

 This difference is called the Contribution


Margin per Unit.
Break even Chart
SOURCES OF DATA FOR
BREAK-EVEN ANALYSIS
 Break-even analysis is a financial tool that helps businesses
determine the minimum amount of revenue they need to
generate in order to cover all their costs—without making a
profit or a loss. It is crucial for assessing the financial viability of
new products, projects, or business models.
Purpose:
• Identify the break-even point (BEP)—where total revenue
equals total costs.
• Assist in pricing decisions, cost control, and profit
planning.
• Analyze the impact of cost structure on profitability.
Key Data Needed for Break-even Analysis:

To perform an accurate break-even analysis, businesses must gather and analyze


the following:
1. Flexible Budget

1. Provides adjusted figures based on different levels of sales or production.

2. Helps estimate costs and revenues under various scenarios.

2. Fixed Costs

1. Costs that do not change with the level of output (e.g., rent, salaries,
insurance).
3. Variable Costs

1. Costs that vary directly with the level of production or sales (e.g., raw
materials, commissions).
4. Sales Revenue

1. Total income from sales of goods or services.


Common Sources of Break-
even Data:

•Financial Statements
Balance sheets and income statements provide data on
expenses and revenues.
•Sales Data
Historical sales figures help forecast future sales and identify
trends.
•Cost of Goods Sold (COGS)
Helps estimate variable costs directly tied to production.
•Operating Expenses
Includes both fixed and variable operating costs necessary to run
the business.
Determining the Break-Even Point

 Each expense must be analyzed to


determine its fixed and variable portions
 Semi-variable expenses must be separated
into their fixed and variable components

 Fixed portion is stated as a total figure


 Variable portion is stated as a rate or
percentage
Determining the Break-Even Point
1. Historical Data: Uses past sales, costs, and performance to estimate the break-even point.
Good for established businesses with reliable records.

Helps answer: "Based on what we did last year, how many units did we need to break even?”

Pros: Realistic and grounded in actual performance.

Easy to calculate if records are available.

Cons: May not reflect changes in the market, pricing, or cost structure.

2. Future Sales and Costs (Forecasting)


Based on expected sales volume, projected costs, and estimated prices.

Useful for new businesses, product launches, or expansion plans.

Helps answer: "If we want to launch this product, how much do we need to sell to break even?”

Pros: Helps with planning, goal setting, and budgeting.

Flexible for exploring “what-if” scenarios.

Cons: Based on assumptions, so it involves more uncertainty or risk.


Determining the Break-Even Point
The Break-even point (BEP) is the level of sales at which total
revenues equal total costs—resulting in zero profit and zero
loss.
Example
Let’s say a company sells handmade candles.
• Selling Price per Unit = $25
• Variable Cost per Unit = $10
• Fixed Costs = $3,000/month
Step 1: CM per Unit=25−10=$15 per Unit
Step2: BEP (units)=3,000/15​=200 Units
Step3: C/M Ratio=15/25​=0.60 or 60%
Step 4: BEP (sales $)=3,000/0.60​=$5,000
Interpretation: The company must generate $5,000 in sales per
month to break even.
Contribution margin ratio (C/M
ratio)
 The Contribution Margin Ratio is a financial metric that
shows the percentage of each sales dollar that contributes
to covering fixed costs and generating profit after
deducting variable costs.
Also known as marginal income ratio or Profit-volume ratio

Contribution Margin (CM) = Sales – Variable Costs


Example
 The ABC Lodge has sales of $4500,000.
The fixed expense was $1,200,000 and the
variable expense totaled $1,800,000.

 Contribution margin ratio ?


 Contribution margin ?
Example
 Contribution margin = Sales revenue - Variable expenses
Contribution margin = $4,500,000 - $1,800,000
Contribution margin = $2,700,000
 The contribution margin ratio can be calculated as

follows:
Contribution margin ratio = Contribution margin / Sales
revenue
Contribution margin ratio = $2,700,000 / $4,500,000
Contribution margin ratio = 0.6 or 60%
 Therefore, the contribution margin ratio for ABC Lodge is

60%. This means that for every dollar of sales revenue,


$0.60 is available to cover fixed expenses and provide
profit.
Income Statement
 Sales xxx
 Less variable expenses xxx
 Total contribution margin xxx
 Less fixed expenses xxx
 Profit xxx
Determining the Break-Even Point
Break-even = Fixed costs
sales volume ($) Contribution margin ratio

Break-even = Fixed costs


sales volume ($) 1 – (Variable costs/Sales)
Determining the Break-Even Point

Break-even = Fixed costs


sales in units Contribution margin/unit

Break-even = Break-even sales in dollars


sales in units Unit sales price
Example
 The ABC Lodge has sales of $4500,000.
The fixed expense was $1,200,000 and the
variable expense totaled $1,800,000.

 Break even point in dollars


Example
 Total cost = Fixed cost + Variable cost
Total cost = $1,200,000 + $1,800,000
Total cost = $3,000,000
 The break-even point in dollars can be calculated as:
Break-even point = Total cost / Contribution margin ratio
Contribution margin ratio = (Sales - Variable cost) / Sales
Contribution margin ratio = ($4,500,000 - $1,800,000) / $4,500,000
Contribution margin ratio = 0.6
Break-even point = $3,000,000 / 0.6
Break-even point = $5,000,000
Therefore, the break-even point in dollars for the ABC Lodge is
$5,000,000.
Equation Approach

The Equation Approach is one method to determine the


break-even point by setting up an equation where:
Total Revenue=Total Costs
Let’s assume:
• Selling Price per Unit = $40
• Variable Cost per Unit = $25
• Fixed Costs = $3,000
Step 1: Set up the equation
40Q=3,000+25Q
Step 2: Solve for Q
40Q−25Q=3,000⇒15Q=3,000⇒Q=200
The business must sell 200 units to cover all costs. Sales
beyond 200 units will result in profit.
Determining the Break-Even Point
Assume:
•Break-even Sales = $60,000
•Actual Sales = $100,000
•Normal Sales Volume = $120,000
•Contribution Margin Ratio = 40%
Break even Chart
 Changes in Fixed expenses
 Original estimate new estimate
 Fixed utilities expenses $1,400 $2,600
 Total Fixed expenses 48,000 49,200

 Breakeven calculation 48,000 49,200


 (FC/unit contribution margin) $6 $6

 Break even point(units) 8,000units 8,200 units


 Break even point (dollars) $128,000 $131,200
Break even Chart

Change in unit variable expenses


Increase in unit variable expenses will cause
a decrease in unit contribution margin.
Break even will now be achieved at a higher

output level.
Break even Chart
 Change in sales price
 Increase in sales price will cause an increase in unit
contribution margin.

 Break even will now be achieved at a lower output


level.

 However, careful analysis by the management is


required as the increase in sales price might also
cause a decline in output sold.
Profit-Volume Analysis
Target Net Profit
 We can use break-even analysis to find the
sales required to reach a target level of
profit.

 Number of sales units required to earn


target profit:
 = Fixed expenses+ Target net profit
Unit contribution margin
Example
 Calculate the number of units the company
needs to sell in order to realize a Profit of
$500,000?
 Given:
 Fixed costs= $100,000
 Sale price= $10
 Variable cost per unit= $5
Constructing a Break-even Chart

 Example:
 Fixed costs = $1,600,000
 Sales = $5,000,000
 Sales/unit = $4
 Variable cost/unit = $2.4/unit
 Construct Break-even chart
BREAK-EVEN ANALYSIS FOR
DECISION MAKING
 for testing proposed actions
 for considering alternatives,
 for other decision-making purposes
Example,
a company's overall contribution margin ratio
[1 — (variable costs ÷sales)] = 25%,
a division manager must realize that for every $1 of proposed
increase in fixed costs, sales revenue must increase by no
less than $4 if the existing profit position is to be
maintained ($1 ÷ 25% = $4)
BREAK-EVEN ANALYSIS FOR
DECISION MAKING
 The break-even analysis formula is also useful in
projecting sales to realize a projected profit or to
minimize a calculated loss. Assume that the
contribution margin ratio (C/M) is 40 percent, that the
fixed costs are $1,600,000, and that the profit objective
is $400,000. The sales figure necessary to realize the
profit objective is:
BREAK-EVEN ANALYSIS FOR
DECISION MAKING

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