costs break-even-analysis

The meaning and importance of break-even analysis

• Break-even analysis is a financial tool used to determine the point at which the business revenue equals its expenses, resulting in neither profit nor loss

• It helps businesses understand the minimum level of sales or output they need to achieve to cover all costs

  • This helps managers make informed decisions about pricing and production volumes

• It is particularly useful for communicating with stakeholders, including investors or lenders

  • It demonstrates the financial viability of the business and gives an insight into potential return on investment

Components of break-even analysis

Sales revenue

• Sales revenue is the value of the units sold by a business over a period of time

  • E.g. the revenue earned by Apple Music from sales of music downloads 

  • Sales revenue is a key business performance measure and must be calculated to identify profit

  • Sales revenue is calculated using the formula

  
   

  • Sales revenue increases as the sales volume increases

Costs

• In preparing goods and services for sale, businesses incur a range of costs

  • Some examples of these costs include purchasing raw materials, paying staff salaries and wages and paying utility bills, such as electricity 

• These costs can be broken into different categories

  • Fixed costs (FC) are costs that do not change as the level of output changes

    • These have to be paid whether the output is zero or 5,000 

  • Variable costs (VC) are costs that vary directly with the output

    • These increase as output increases and vice versa

  • Total costs (TC) are the sum of the fixed and variable costs 

Calculating the break-even point

• Breakeven is calculated using the formula

• Contribution per unit is used to calculate the breakeven point

  • It is calculated using the formula

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