\[\text{Break-Even} = \frac{\text{Fixed Costs}}{\text{(Sales price per unit} – \text{Variable costs per unit)}} \]
Brackets first.
Break-even is when a company’s total revenue equals its total costs, resulting in no profit or loss.
Variable costs are the expenses paid out that change based on production or sales like material costs, while fixed costs do not such as rent.
Revenues are the income a company earns from sales, it is money coming into the business.
Profit is the amount earned after costs are deducted.
Loss occurs when costs exceed revenue.
Margin of safety is the number of sales or revenue above the break-even point, providing a cushion for unexpected expenses or changes in the business environment.
This is a recap of lesson 6.2.1 Financial terms and calculations.
Remember for the exam:
Constructing a Break-Even Chart
A break-even chart is a graphical representation of costs, revenues, and profits. It is a useful tool for businesses to determine the sales volume required to cover all costs, the point at which profits start, and the margin of safety. Here’s how to construct a break-even chart:
1. Draw a chart with two lines, one going across (left to right) and one going up (bottom to top). The line going across shows Quantity, how many items you sell. The line going up shows revenue and costs, the £ you make or spend.
2. Label the numbers along the bottom of the graph using the Quantity numbers in the table starting at 0. Then, label the revenue scale along the side using the numbers from the revenue column, starting at 0.
When faced with a lengthy break-even table during an exam, it is recommended to simplify the process by plotting only the first and last rows and connecting the lines. This method enables the plotting of the minimum and maximum quantity, saving you time in the exam! Simply follow along the bottom to locate the output, followed by a vertical line up to find the revenue or Cost in £s. Finally, join all the plot marks together.
3. Draw a straight line for your fixed costs (costs that don’t change). Start from the money line (vertical line) at the height of your fixed costs and go straight across.
4. Draw a line for variable costs start from 0 if output is 0.
5. Draw a line for total costs (fixed costs + variable costs that change). Start from the fixed costs line, and make a line that goes up as you sell more items.
6. Draw a line for the revenue (money you make from selling items). Start at the bottom corner (0,0) and make a line that goes up as you sell more items.
7. Find the break-even point. This is where the total costs line and the revenue line meet. At this point, you’ve covered all your costs and start making a profit.
Margin of Safety
Margin of Safety is the difference between the actual sales and the break-even point. It represents the cushion or buffer that a business has before it starts to make a loss. It can be expressed as a percentage of the actual sales.
To calculate the margin of safety, you can use the following formula:
Margin of safety = Actual sales – Break-even sales
For instance, let’s say a company has a break-even point of 500 units and they have sold 750 units. In this case, the margin of safety would be:
Margin of safety = 750 – 500
= 250 units
