Breakeven Analysis Row

BUSINESS
MATHEMATICS
Breakeven Analysis
Breakeven Analysis Defined
 Breakeven can be defined as the minimum level

of sales revenue or units of goods that an
organisation must meet or produce to cover all
costs.
 To determine these level, costs must be
determined appropriately and accurately.
 To determine cost accurately, the cost of every
factor of production (land, labour, capital, and
entrepreneur must be accounted for.
Break-Even Analysis
 The Objective of breakeven analysis is to
find the level of output at which cost
equals revenue
 Requires estimation of fixed costs,
variable costs, and revenue
Break-Even Analysis
 Fixed costs are costs that continue even if
no units are produced
 Depreciation, taxes, debt, mortgage payments
 Variable costs are costs that vary with the
volume of units produced
 Labor, materials, portion of utilities
 Contribution is the difference between selling
price and variable cost
Break-Even Analysis
Assumptions
 Costs and revenue are linear functions
 Generally not the case in the real world
 We actually know all the costs
 Very difficult to accomplish
 There is no time value of money
Decision making and Breakeven
Analysis
 How many units must be sold to breakeven?
 How many units must be sold to achieve a target
profit?
 How will profits and or breakeven volume be
affected if fixed cost, variable cost, and or total
revenue increased or reduced?
Key Terminology: Breakeven
Analysis
 Break even point-the point at which a company
makes neither a profit or a loss (i.e. total revenue is
equal to total cost – TR = TC)
 Contribution per unit-the sales price minus the
variable cost per unit. It measures the contribution
made by each item of output to the fixed costs and
profit of the organisation.
(i.e. price per unit – variable cost per unit)
Key Terminology ctd.
 Margin of safety-a measure in which the budgeted volume of
sales is compared with the volume of sales required to break
even.
(i.e. Budgeted volume of sales – Breakeven volume)
Example:
If a firm budgets to sell 2000 units and it requires 1600 units to
breakeven, then the margin of safety is: 2000 – 1600 = 400.
(We could also use the value of these goods in cedis to determine the
margin of safety)
 Marginal Cost – cost of producing one extra unit of output

Breakeven Formula
 Breakeven volume can be determined
mathematically or graphically.
Fixed Cost
Price per unit – Variable cost per unit
Selling Price per unit – Variable Cost per unit = Contribution per unit
NB: This formula is used to determine the breakeven for single

items only. To determine breakeven for multiple items, the
multiple case formula is used.
Break-Even Analysis
BEPq = Break-even point in units q = Number of units produced
P= Price per unit (after all discounts)
TR = Total revenue = P x q
F = Fixed costs
Vq = Variable costs per unit
TC = Total costs = F + Vx
Break-even occurs when
TR = TC F
or BEPq =
P-V
Pq = F + Vq
Example
 Ante Araba sells biscuits in a shop around the
corner. If her monthly fixed cost is Ȼ1,800 and her
variable cost per unit is Ȼ6.75, determine the
number of biscuits Ante Araba must sell to
breakeven if a biscuit sells at Ȼ9.25.
 Solution
BEPq = f = 1800 =Ȼ 654.5
p–v 9.25 – 6.75
Example
Determine the breakeven volume if
Fixed costs = Ȼ10,000 Material = Ȼ0.75/unit
Direct labor = Ȼ1.50/unit Selling price = Ȼ4.00 per unit
BEPq = F = $10,000
p-v [400 – (1.50 + 0.75)]
Note that variable cost was given here as cost of labour and material.
Break-Even in Monetary Terms
BEPq = Break-even point in units q = Number of units produced
BEPȻ = Break-even point in dollars
P = Price per unit (after all TR = Total revenue = PQ
discounts) F = Fixed costs
V = Variable costs
TC = Total costs = F + Vq
BEP$ = BEPq × P
= F P Profit = TR - TC
P-V = Pq - (F + Vq)
= F
= Pq - F - Vq
(P - V)/P
F = (P - V)q - F
=
1 - V/P
Example
Determine the value of sales at breakeven if:
Fixed costs = Ȼ10,000 Material = Ȼ0.75/unit
Direct labor = Ȼ1.50/unit Selling price = Ȼ4.00 per unit
BEPȻ = F
= Ȼ10,000
1 - (V/P)
1 - [(1.50 + .75)/(4.00)]
Ȼ10,000
= .4375 = Ȼ22,857.14
F Ȼ10,000
BEPq = = = 5,714 units
P-V 4.00 - (1.50 + .75)
Graphical Representation of Example in
Previous Slide
50,000 –
Total Revenue
40,000 –
Break-even
point Total
30,000 –
costs
Cedis
20,000 –
Fixed costs
10,000 –
–| | | | | |
0 2,000 4,000 6,000 8,000 10,000
Units
Graphical Breakeven Analysis
–
Total revenue line
900 –
800 –
Break-even point Total cost line
700 – Total cost = Total revenue
Cost/Revenue in cedis
600 –
500 –
400 – Variable cost
300 –
200 –
100 – Fixed cost

–
| | | | | | | | | | | |
0 100 200 300 400 500 600 700 800 900 1000 1100
Volume (units per period)
Multiproduct Breakeven Analysis
 What we have discussed so far applies to
single products or items only. Where the firm
deal with multiple products, the multiple
product formula is used.
 The breakeven under the multiple product is
determine in monetary terms only.
 That means that if the firm wants to know
how much of each item to sell to breakeven,
they have to use the single case approach
Multiple Product Formula
Multiproduct Case
F
BEPȻ =
∑ 1-
Vi
Pi x (Wi)
where V = variable cost per unit

P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
i = each product
Multiproduct Example
Fixed costs = Ȼ3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sardine Ȼ2.95 Ȼ1.25 7,000
Soft drink .80 .30 7,000
Biscuit 1.55 .47 5,000
Pencil .75 .25 5,000
Milk 2.85 1.00 3,000
Fixed costs = $3,500 per month
Annual Forecasted
Item Price Cost Sales Units
Sandwich $2.95 $1.25 7,000
Soft drink .80 .30 7,000
Baked potato 1.55 .47 Annual 5,000 Weighted
Tea Selling Variable .75 .25 Forecasted 5,000
% of Contribution
Item (i) Price (P) Cost (V) (V/P) 1 - (V/P) Sales $ Sales (col 5 x col 7)
Salad bar 2.85 1.00 3,000
Sardine $2.95 $1.25 .42 .58 $20,650 .446 .259
Soft drink .80 .30 .38 .62 5,600 .121 .075
Biscuits 1.55 .47 .30 .70 7,750 .167 .117
Pencil .75 .25 .33 .67 3,750 .081 .054
Milk 2.85 1.00 .35 .65 8,550 .185 .120
$46,300 1.000 .625
Fixed costs = $3,500 per month and so to get annual, we multiply by 12
F
BEPȻ =
∑ 1-
Vi
Pi
x(Wi)
Ȼ3,500 x 12
=
.625
= Ȼ67,200
Margin of Safety
 The difference between budgeted or actual
sales and the breakeven point
 The margin of safety may be expressed in
units or revenue terms
 Shows the amount by which sales can drop
before a loss will be incurred
Example 1
Using the following data, calculate the
breakeven point, contribution per unit and
margin of safety in units:
 Selling Price = Ȼ50
 Variable Cost = Ȼ40
 Fixed Cost = Ȼ70,000
 Budgeted Sales = 7,500 units

Example 1: Solution
 Contribution = Ȼ50 - Ȼ40 = Ȼ10 per unit
 Breakeven point = Ȼ70,000/Ȼ10 = 7,000 units
 Margin of safety = 7500 – 7000 = 500 units
 To determine the margin of safety in
monetary terms, we multiple 500 by 50 to get
Ȼ25,000
Target Profits
 Sometime, firms do not just want to
breakeven. They may want a target profit
 In that case, contribution per unit will need to
cover profit as well as fixed costs
 Required profit is accordingly treated as an
addition to Fixed Costs
Example 2
Using the following data, calculate the level of
sales required to generate a profit of Ȼ10,000:
 Selling Price = Ȼ35
 Variable Cost = Ȼ20
 Fixed Costs = Ȼ50,000

Example 2: Solution
 Contribution = Ȼ35 – Ȼ20 = Ȼ15
 Level of sales required to generate profit of
Ȼ10,000:
Ȼ50,000 + Ȼ10,000
Ȼ15
= 4000 units
 The firm will need to sell 4000 units to not
only breakeven, but make a target profit of
Ȼ10,000

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BUSINESS

 Breakeven can be defined as the minimum level

 Marginal Cost – cost of producing one extra unit of output

NB: This formula is used to determine the breakeven for single

Break-even occurs when

400 – Variable cost

100 – Fixed cost

where V = variable cost per unit

 Variable Cost = Ȼ40

 Fixed Cost = Ȼ70,000

 Budgeted Sales = 7,500 units

 Variable Cost = Ȼ20

 Fixed Costs = Ȼ50,000

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