Lecture 5 BREAK-EVEN LEVEL OF OUTPUT = FIXED COSTS
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Break-even analysis – further uses
Charts can be redrawn showing potential new situation and this can then be compared with the existing
position of the business. Care must be taken in making these comparisons, as forecasts and predictions
are usually necessary.
Examples of further uses of the break-even technique:
1. A marketing decision – the impact of a price increase
2. An operations-management decision – the purchase of new equipment with lower variable costs.
3. Choosing between two locations for a new factory.
The usefulness of break-even analysis can be summarised as follows:
Charts are relatively easy to construct and interpret
Analysis provides 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
Break-even point of production: the level of output at which total cost equal total revenue – neither a
profit nor a loss is made.
Break-even analysis can be undertaken in two ways:
The graphical method – the break-even chart.
Usually drawn using three pieces of information:
Fixed costs: will not vary in a short term the level of output which must be paid whether the firm
produces anything or not.
Total costs: addition of a fixed and variable costs; variable cost vary in proportional to the output Sales revenue starts at the origin (0), no sales made = no revenue.
Variable-cost line starts at the origin (0), no good produced = no variable cost. (not necessary to
interpret the chart, often omitted)
Total cost-line starts at the level of fixed costs, difference between are total and fixed cost being
accounted for by variable costs.
The point at which the total-cost and sales-revenue lines cross (BE) is the break-even point. At
productions levels below the break-even point, the business is making a loss; at production levels above
the break-even point the business is making a profit.
Evaluation of break-even analysis
This analysis also has limitations:
- The assumption that cost and revenues are always represented by straight lines in unrealistic. Not all
variable costs change directl