Break-Even Analysis
Business: Edexcel IGCSE, topic 3.3.5
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 Break-Even Analysis
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?
A coffee shop has a total cost of £700 and a revenue of £1,600, what is their margin of safety?