What is break-even analysis?

A calculation using cost and revenue to determine the minimum output required for a firm to make a profit

How does break-even analysis help firms make business decisions?

Using a break-even analysis, a firm can estimate the minimum output required to make a profit or break-even. As such, this forecast is useful in a business plan.

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The total cost (TC) is the sum of the fixed cost (FC) and variable cost (VC).

The firm makes a profit when its total revenue (TR) is more than (is above) the total cost in the chart. At 100,000 unit, the TR is equal to TC. As such, the firm shall earn a profit when it produces and sells more than 100,000 units, as TR exceeds TC. The break-even output is therefore 100,000 unit.

Besides using the break-even chart, the break-even point could also be calculated using the break-even formula.

The sales price per unit is the price of the unit product that is sold, while the variable cost per unit is the unit cost for producing each unit that excludes fixed cost. It is not the same as average cost, as the average cost is the total cost per unit.

A margin of safety is the difference between the current level of output and the breakeven output.

Fixed cost are cost that do not change with the change in level of output. Examples of fixed cost are workers salary, rental of premise and etc.

Average Cost = Total Cost ➗ Total No. of Units

RELEVENT QUESTIONS

1. How do you calculate the total cost?

2. How do you calculate the total revenue?

RELEVANT CONCEPTS

1. Total Cost

2. Total Revenue

3. Variable Cost

4. Fixed Cost

5. Profit

6. Average Cost

PAST YEAR QUESTIONS

1. Define 'margin of safety' (2 marks) May/June 2020/13

2. What is meant by "break-even"? (2 marks) May/June 2019/11

3. What is meant by ‘break-even output’? (2 marks) Oct/Nov 2018/13

4. Calculate the break-even number of customers for a typical flight. Show your working. (2 marks) May/June 2020/11

5. Identify two fixed costs for a firm. (2 marks) May/June 2018/12

6. What is meant by ‘variable cost’? (2 marks) Feb/Mar 2019/12

7. What is meant by ‘total cost’? (2 marks) May/June 2019/11

8. What is meant by ‘fixed costs’? (2 marks) May/June 2019/12 & Oct/Nov 2019/11

9. Calculate the total cost of producing 3 million cricket bats. (2 marks) Feb/Mar 2019/12

10. Calculate the average cost of one motorcycle. Show your working (2 marks) May/June 2020/12

Read all post from Unit 4 - Operations Management