Break Even

Break Even

1. Contribution

   • For each item that a business sells it must first cover the variable costs. What is left is used to contribute to fixed costs and then, after these all are paid for, to contribute to profit
   • Contribution per unit
     • The amount of money that each unit sold contributes towards fixed costs and once break even has been achieved then contributes to profit
   • Calculated as
     • Selling price - variable cost per unit
   • Example
     • T-Shirts sell at £11.50 and each one costs £4 to make. Each item sold makes a contribution of £7.50 (£11.50-£4)

2. Break Even analysis

   • A numerical technique used by businesses to identify the number of units neccessary to achieve an equilibrium where total costs are equal to total revenue
   • Break even point is where total fixed costs+total variable costs=total revenue
   • Break even point can be calculated using contribution. The formula is fixed costs/contribution
   • Example
     • The fixed costs to manufacture the T-shirts is £15000. Contribution=SP-VC=£11.50-£4+£7.50. Fixed cost/contribution=break even point. £15000/£7.50=2000 units. The business would have to sell 2000 t-shirts to break even

3. Uses

   • Set targets for minimum sales
   • Show to potential investors to illustrate ability to potentially make a profit
   • Assess impact of changing variables
   • Calculate profit and loss at different levels of output
   • Help make decisions such as whether a special order should be accepted
   • If the lower selling price still covers variable costs and a business has spare capacity then a special contract will still contribute to fixed costs or profit if it is accepted

4. Margin of safety

   • The difference between the actual number of units produced and the number required to break even. The bigger the margin of safety the greater the profit