Break Even Analysis
1. Discuss the concept and principles of break even analysis and its graph.
Businesses use break-even analysis as a financial tool to identify the point at which total
revenue and total costs equal one another and there is no profit or loss. Its guiding concepts
center on differentiating between fixed costs, which don't change with production, and variable
costs, which do. The break-even point is visually represented as the intersection of the total
revenue and total cost functions graphed against the amount of activity, usually units sold or
production volume. The business experiences a profit above this threshold and a loss below it.
Decision-making is facilitated by the insights this study offers on pricing strategies, production
levels, and general business viability.
2. Provide examples
This visual representation helps businesses understand
the relationship between costs, revenue, and profitability
at different levels of activity. The horizontal axis
represents the level of activity, typically units sold or
production volume.The vertical axis represents both total
cost and total revenue The total cost line starts at the
fixed cost level and rises as production increases,
representing both fixed and variable costs.The total
revenue line starts from the origin and slopes upwards
as sales increase. The break-even point is where the
two lines intersect, indicating the level of activity at
which total revenue equals total cost. Above the
break-even point, the company makes a profit, while
below it, the company incurs a loss.
Photo from::https://www.geeksforgeeks.org.
Example:
Suppose a bakery incurs ₱5,000 in fixed costs per month. Each cupcake sells for
₱3, and the variable cost per cupcake (including ingredients and labor) is ₱1.50.
Calculate the contribution margin per cupcake:
(Selling Price per cupcake - Variable Cost per cupcake)
= ₱3 - ₱1.50
= ₱1.50
Calculate the contribution margin ratio:
(Contribution Margin per Cupcake / Selling Price per cupcake)
= ₱1.50 / ₱3
= 0.50 or 50%
calculate the break-even point in units: Fixed Costs / (Selling Price per cupcake - Variable Cost
per cupcake)
= ₱5,000 / (₱3 - ₱1.50)
= 5,000 / 1.50
= 3,333.33 cupcakes
So, the bakery needs to sell approximately 3,334 cupcakes to break even.
Break-even point (sales revenue) = Fixed Costs / Contribution Margin Ratio
= ₱5,000 / 0.50
= ₱10,000
So, the bakery needs to generate ₱10,000 in sales revenue to break even.
