Chapter 16 - Costs, Scale of Production, and Break-Even Analysis
Lesson Objective: To understand how to construct and interpret the break-even analysis
The break-even point is the point in which the cost and revenue are equal and there is neither profit nor loss being made by the business:
In other words, the break even point happens when all revenues earned by the firm with sales is equals to the firm's costs of production.
When you are at break even and want to make profit, therefore:
Anything below the break even point mean higher costs than revenues = loss;
Anything above the break even point mean higher revenues than cost = profit.
And so, the break-even analysis shows the relationship between revenue, costs, and volume of outputs.
This analysis is used for different purposes:
Helps understanding the minimum amount of units needed for becoming profitable;
To visualize the impact of costs (increase or decrease) on profits;
To understand the business profit at different output levels;
It also helps calculating the margin of safety.
Let's now look at what you will need to build a break-even chart and finding the break-even point:
Variable costs per unit or total variable costs;
Fixed costs;
Total costs;
Output or number of products to be sold (volume);
Price per unit.
Example (p. 224)
Activity 16.6
Activity 16.7
* Margin of safety is a simple measure to tell the business what is the minimum amount of sales it can have before it falls into losses.
Final considerations on break-even analysis:
Building the graph will help the business understand the impacts of a change in price of its products on the demand (sales) and consequentially profit;
It will also help to understand the impacts of change in costs on the business profitability (e.g. supplier increase in prices).
Activity 16.9
To-Do-List:
Exam Practice Questions (p. 227 and 228)
Chapter 16 - Costs, Scale of Production, and Break-Even Analysis
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