Break-Even AnalysisFurther Uses

Unit 5 Operations Management

Learning ObjectivesHL – Use these methods to analyse the effects

of changes in price or cost on break even , profit and margin of safety

HL - Calculate the required output level for a given target revenue or profit

Analyse the assumptions and limitations of break even analysis

Break Even Analysis• Can also be used to assist managers in making

key decisions • Charts can be redrawn showing a potential

new situation – this can then be compared with the existing position of the business

• 3 examples of further uses of break even technique

HL

1. A marketing decision

• Impact of the price increase, this will raise the sales revenue line at each level of quantity sold

HL

Units of output

0

Cost

s and

sale

s rev

enue

Sales

Full Capacity

Sales Revenue 2

Where is the new break even?

HL

2. An operations management decision

• Purchase of new equipment with lower variable costs, this will lower the variable cost line at each level of quantity

HL

Units of output

0

Cost

s and

sale

s rev

enue

Sales

Full Capacity

Fixed costs 2

Total cost 2

HL

3. Choices• Choosing between 2 locations for a new

factory – with different fixed and variable costs

HL

Target Revenue and Profit• Adapted version of the break even formula

can be used if the business wants to determine a target profit level and establish the level of output required to achieve it

• Formula changes to

Target profit level of output =

Fixed costs + target profit

Contribution per unit

If the target profit is $25,000, fixed costs are $200,000 and contribution per unit $50Level of output needed to earn the target profit is

HL

Break Even Revenue

• The amount of revenue needed to cover both fixed and variable so that the business breaks even

HL

An evaluation – Usefulness

• Charts are relatively easy to construct and interpret• Useful guidelines to management on break even

points, safety margins and profit / loss levels at different rates of output

• Comparisons can be made between different options by constructing new charts to show changed circumstances

• Equation produces a precise break even result• Can be used to assist managers when taking important

decisions

An evaluation - Limitations

• The assumption that costs and revenues are always represented by straight lines is unrealistic

BE1 BE2

TC

SR

FC

An evaluation - Limitations

• Not all costs can be conveniently classified into fixed and variable costs (semi – variable costs)

• No allowance for stock levels, break even chart assumes all units produced are sold

(iii) Evaluate the usefulness of using break even charts (8)

Answers

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