Calculating Break-Even
How many sales before a new business stops making a loss? Work out the contribution per unit, calculate the break-even level of output, find the margin of safety, and read a break-even diagram.
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Will it break even?
Every new business wants to know: how many items must it sell before it stops making a loss? That point is called break-even. This module shows how to calculate the break-even level of output, work out the margin of safety, and read a break-even diagram.
The language of break-even
Four ideas run through this module:
The break-even formula
To find break-even, first work out the contribution per unit: contribution = selling price minus variable cost per unit. Then: break-even output = fixed costs divided by the contribution per unit. At break-even, total revenue equals total costs, so the business makes neither a profit nor a loss.
Work out the contribution
A product sells for 10 pounds. Each unit has variable costs of 6 pounds. Contribution = price minus variable cost. What is the contribution per unit, in pounds?
Find the break-even output
The business has fixed costs of 2000 pounds, and each unit gives a contribution of 4 pounds. Break-even = fixed costs divided by contribution. How many units must it sell to break even?
Steps to break-even
Put the steps for calculating the break-even output into the right order.
- Find the selling price and the variable cost per unit
- Subtract to get the contribution per unit
- Find the total fixed costs
- Divide the fixed costs by the contribution per unit
- The result is the break-even level of output
Reading a break-even diagram
On a break-even chart the total revenue line and the total cost line cross at the break-even point.
Plot the revenue line
On a break-even chart, total revenue rises with output. Each unit sells for 10 pounds, so three points are plotted. Plot the total revenue at an output of 300 units.
What is break-even?
What is true at the break-even level of output?
- Total revenue exactly equals total costs
- The business makes its biggest profit
- The business has no costs at all
- Sales have fallen to zero
Margin of safety
The break-even output is 500 units, and the business actually sells 700 units. Margin of safety = actual output minus break-even output. What is the margin of safety, in units?
Break-even in words
The contribution per unit is the selling price minus the _____ cost. The break-even output is the fixed costs _____ by the contribution. At break-even, total revenue equals total _____, so the business makes neither a profit nor a _____. Selling more than the break-even level gives a margin of _____.
Break-even facts
Select the TWO statements that are TRUE about break-even.
- A higher contribution per unit lowers the break-even output
- The margin of safety shows how far sales can fall before a loss
- Higher fixed costs lower the break-even output
- Break-even output is fixed costs multiplied by contribution
Match each idea
- Contribution
- Break-even output
- Margin of safety
- Break-even point
- Selling price per unit minus variable cost per unit
- Fixed costs divided by the contribution per unit
- Actual output minus the break-even output
- Where total revenue equals total costs on the chart
Explain break-even
A cafe owner wants to know her break-even point. Explain how she would calculate it and why it is useful. Write in full sentences and show the method.
- Explain what contribution per unit is and how to find it
- Explain how to calculate the break-even level of output
- Explain what the margin of safety tells the owner
- Explain one reason knowing the break-even point helps a business