CONTENTS
definition
Purpose
Construction/Computation
Margin of safety
Types of costs
Limitations
conclusion
DEFINITION
“Break even point (Bep) is the point
at which cost or expenses and
revenue are equal”
Alternate option
Try to reduce the fixed costs (by renegotiating rent for example,
or keeping better control of telephone bills or other costs)
Try to reduce variable costs (the price it pays for the tables by
finding a new supplier)
Where, marginal cost and marginal revenue are constant BEP can be directly
computed in terms of total revenue(TR) and total cost (TC)
V
. is Unit Variable Cost
FORMULA
Q3 Q1 Q2 Output/Sales
Important things to be considered before
conducting break- even analysis
FIXED COST
VARIABLE COST
SETTING PRICE
PHYCHOLOGY OF PRICING
PRICING METHODS
TheAs Break-even
output is point
Costs/Revenue Total
The
occurs revenue
Thewhere
total total
lower is
costs
the
TR TR TC generated,
Initially a by
determined
therefore
the
firm the
VC price,
revenue
firm the
equals
will
willcharged
less
total
incur
incur fixed
price
costs – the
(assuming firm, and
in
steep the
variable
costs, total
costs
thesesolddo– –
thisthe quantity
example
accurate
these vary would
revenue
not depend
again
to this
haveforecasts!)
sell
curve.
Q1
onbe
willto
directly
output or
determined with is
the
sales.
by the
generate
sum
amount sufficient
of produced
FC+VC
expected
revenue to cover forecastits
sales
costs. initially.
FC
Q1 Output/Sales
Break-Even Analysis If the firm
chose to set
price higher
Costs/Revenue than £2 (say
TR (p = £3) TR (p = £2) TC
VC £3) the TR
curve would
be steeper –
they would
not have to
sell as many
units to
break even
FC
Q2 Q1 Output/Sales
Break-Even Analysis
TR (p = £1)
Costs/Revenue If the firm
TR (p = £2)
TC chose to set
VC
prices lower
(say £1) it
would need
to sell more
units before
covering its
costs
FC
Q1 Q3 Output/Sales
example,
suppose that your fixed costs for
producing 100,000 product were 30,000 rs a
year.
Your variable costs are 2.20 rs materials,
4.00 rs labour, and 0.80 rs overhead, for a
total of 7.00 rs per unit.
If you choose a selling price of 12.00 rs for
each product, then:
30,000 divided by (12.00 - 7.00) equals
6000 units.
This is the number of products that have
to be sold at a selling price of 12.00 rs
before your business will start to make a
profit.
LIMITATIONS
•Break-even analysis is only a supply-side (i.e., costs only)
analysis, as it tells you nothing about what sales are actually likely
to be for the product at these various prices.
•It assumes that fixed costs (FC) are constant. Although this is
true in the short run, an increase in the scale of production is likely
to cause fixed costs to rise.
•It assumes average variable costs are constant per unit of output,
at least in the range of likely quantities of sales. (i.e., linearity).
It assumes that the quantity of goods produced is equal to the
quantity of goods sold (i.e., there is no change in the quantity of
goods held in inventory at the beginning of the period and the
quantity of goods held in inventory at the end of the period).