Business Profits & Break-Even Analysis
Business: Edexcel GCSE, topic 1.3.6
Profit, Average Unit Cost and Interest
Profit is the amount of money that the business makes, when taking into account costs. It is in effect, a surplus.
Profit
- Profit = total revenue – total costs.
- This is a simple and yet very important formula.
- If revenue is greater than costs, a company will make a profit.
- If costs are greater than revenue, a company will make a loss.
Average unit cost
- Average unit cost = total cost ÷ output (total number of units produced).
- This gives a business an idea of what price they need to charge.
- In order to make a profit on each item, they need to charge a price that is more than the average unit cost.
Interest
- When you borrow money, you usually pay back more than you borrowed. This extra amount is known as the interest on the loan and it is the percentage of the loan that is charged as extra.
- Interest = interest rate x the size of the loan.
- So, if a business borrows £200 at an interest rate of 5%. Then the interest they pay on the loan each year is 200 x 0.05 = £10.
Break-Even Analysis
The break-even point is the amount of sales when a business’ revenue is equal to the total costs of a business. At this point, the business is not making a profit or a loss.
Break-even analysis
- If the business sells more than the break-even level of output then it will make a profit and if it sells less, it will make a loss.
- Businesses use this to calculate the output needed to make a profit.
- The break-even level of output is the level of output at which the firm’s revenue is equal to the total costs.
- Break-even analysis can be shown by a break-even chart which shows total costs, revenue and profit on the y-axis and output on the x-axis.
Margin of safety
- Margin of safety is how much output (or predicted output) would have to fall by until the business reached the break-even level of output.
- The margin of safety is the gap between the actual output and the break-even point.
Analysing projects
- Knowing the break-even point is helpful when analysing investment projects.
- E.g. if Cadbury were launching a new chocolate bar, they could use break-even analysis on the new chocolate bar and then compare that to the predictions of how much they think they will sell.
Limitations to break-even analysis
- Break-even analysis makes some assumptions that may not be accurate in reality.
- Assumes the firm will be able to sell all of the units that it produces.
- Assumes the firm would not have to change the price when output changes.
Test yourself on Business Profits & Break-Even Analysis
What is the equation for profit?
If a hot dog van has a total cost of £1500 and produces an output of 750 hotdogs, what is the average unit cost of 1 hot dog?
If a business borrows a loan of £9,000 at an interest rate of 2%, how much interest will they pay on the loan each year?
What is the break-even point?
If a sweatshirt company has a total cost of £5,000 and they sell each jumper they make for £20, how many jumpers will they need to sell to break-even?