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3.3 Break-Even Analysis

What is Break-even?

Breaking-even is when the revenues equal the costs of production or service.

In financial terms, a business can be in one of the following situations at any point in time:

Loss - when costs of production exceed the revenues of the business

Break-even - when the revenues of the business equal the costs of production

Profit - when revenues exceed costs of production.

Profit calculations:

Total Revenue - Total cost
Margin of Safety x Contribution per Unit

Variable Cost = The cost per unit made
Margin of Safety = The difference between actual sales and the breakeven point

How to Calculate the Breakeven Point:

Fixed Costs / Selling Price - Variable Cost

Contribution:

Refers to the sum of money that remains after all direct and variable costs have been taken away from the sales revenue

Formulas according to Contribution:

Contribution per Unit = Price - Average Variable Cost

Total Contribution = ( Price - Average Variable Cost ) x Quantity

Profits = Total Contribution - Total Fixed Cost

Limitations of Break-Even Analysis Graphs

Information could be unreliable because it is based on forecasts and predictions
Assumes Selling Price stays the same regardless of output
Fixed Costs may not stay the same
Ignores factors such as economies of scale
Assumes that all output is sold
Only suitable for analysis of single products
Only considers quantitative factors.

Practice Questions for Break-even Analysis from Past IB Exams

You must do this on a piece of graphing paper and draw the break-even analysis with a pencil & ruler.

From the financial information provided in the exam question, prepare a fully labeled break-even chart for Himalayan Trekking (HT) for 2013:

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