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Business Finance Costs Break-Even Analysis

Business Finance Costs Break-Even Analysis. Revenue and Costs. “ Revenue ” is income earned by a firm when they sell either the goods it makes or the services it offers. Money received from customers is called sales, sales revenue or turnover .

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Business Finance Costs Break-Even Analysis

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  1. Business Finance Costs Break-Even Analysis

  2. Revenue and Costs “Revenue” is income earned by a firm when they sell either the goods it makes or the services it offers. Money received from customers is called sales, sales revenue or turnover. “Costs” are all the types of expenditure that a firm has when it first starts up and when it is operating on a day-to-day basis.

  3. Revision … Costs that do not vary with output are called: FIXED COSTS Costs that do vary with output are called: VARIABLE COSTS The money a business receives from its customers is called: REVENUE (OR SALES REVENUE) To calculate profit, you do the sum: Total revenue minus ? TOTAL COSTS The point at which total revenue equals total costs is called: THE BREAK-EVEN POINT

  4. Fixed and Variable Costs Fixed Costs Costs that DO NOT change when the level of output changes. Fixed costs stay the same whether a firm is producing 100 units or 1,000 units. Fixed costs still have to be paid even if nothing is produced. eg: rent, rates, insurance, wages, leasing equipment, electricity bill Variable Costs Costs that DO change when the level of output changes. The more that is produced, the more of these items have to be purchased. eg stock and raw materials Would the item be paid for if nothing was produced? If yes, it is a FIXED COST

  5. Fixed or Variable Cost? Loan repayment to a bank Fixed Cost Purchase of CDs and USB sticks Variable Cost Insurance for the web design premises Fixed Cost Wages Fixed Cost Purchase of paper to print invoices to customers Variable Cost

  6. Constructing a Break-Even Chart Sales revenue £ Profit if we hit our sales target Total Costs Break-even Point Fixed Costs Margin of Safety Output

  7. Break-even Table: based on a price of £200 800 800 800 800 800 0 400 800 1200 1600 800 1200 1600 2000 2400 0 800 1600 2400 3200 Fixed costs are £800, the variable cost per unit is £100

  8. Break-Even Chart: Price £200 £ Revenue Sales revenue 3200 2800 Total Costs 2400 Break even Point = 8 units 2000 Break-even Point Profit if we sell 12 units = £400 1600 1200 Loss if we only sell 4 units = £400 Fixed Costs 800 400 4 8 12 16 Number of units

  9. Break-even Table: based on a price of £100 200 200 200 200 200 0 100 200 300 400 200 300 400 500 600 0 200 400 600 800 Fixed costs are £200, the variable cost per unit is £50

  10. Break-Even Chart: Price £50 £ Revenue Sales revenue 800 700 Total Costs 600 500 Break-even Point Profit if we sell 6 units = £100 400 300 Loss if we only sell 2 units = £100 Fixed Costs 200 100 2 4 6 8 Number of units

  11. Calculating the break-even point without a graph To calculate how many products we need to sell in order to break even and cover our costs. Formula: Fixed Costs Contribution (Price – Variable cost)

  12. Use the break-even formula to work out the break-even point for questions 1-5 below Formula: Fixed Costs Contribution (Price – Variable cost) • Fixed cost = £20,000, price = £4,000, variable cost = £2,000 2. Fixed cost = £10,000, price = £4,000, variable cost = £2,000 3. Fixed cost = £26,000, price = £5,000, variable cost = £3,000 4. Fixed cost = £50,000, price = £20,000, variable cost = £10,000 5. Fixed cost = £1,000, price = £800, variable cost = £300 20,000 / 2,000 = 10 10,000 / 2,000 = 5 26,000 / 2,000 = 13 50,000 / 10,000 = 5 1,000 / 500 = 2

  13. Using the Break Even Formula Fixed Costs Price – Variable Cost • Fixed cost = £600, price = £400, variable cost = £100 2. Fixed cost = £10, price = £3, variable cost = £1 3. Fixed cost = £260, price = £50, variable cost = £30 4. Fixed cost = £50,000, price = £4,000, variable cost = £2,000 5. Fixed cost = £1,000, price = £400, variable cost = £200 600 / 300 = 2 10 / 2 = 5 260 / 20 = 13 50,000 / 2,000 = 25 1,000 / 200 = 5

  14. Finance Terms Variable Cost Fixed Cost Total Costs Sales Revenue Break Even Point

  15. Break-even Table: based on a price of £100 500 500 500 500 500 0 250 500 750 1000 500 750 1000 1250 1500 0 500 1000 1500 2000 Fixed costs are £500, the variable cost per unit is £50

  16. Break-Even Chart: Price £50 £ Revenue Sales revenue 2000 Total Costs 1500 Break-even Point Profit if we sell 15 units = £250 1000 Loss if we only sell 5 units = £250 Fixed Costs 500 5 10 15 20 Number of units

  17. Using the Break Even Formula Fixed Costs Price – Variable Cost • Fixed cost = £600, price = £400, variable cost = £100 2. Fixed cost = £10, price = £3, variable cost = £1 3. Fixed cost = £260, price = £50, variable cost = £30 4. Fixed cost = £50,000, price = £4,000, variable cost = £2,000 5. Fixed cost = £1,000, price = £400, variable cost = £200 600 / 300 = 2 10 / 2 = 5 260 / 20 = 13 50,000 / 2,000 = 25 1,000 / 200 = 5

  18. Effect on the BEP if costs or revenue change If fixed costs or variable costs increase, the BEP will increase – the firm will have to sell more products to cover their costs. If the selling price is increased, the BEP will decrease – the total revenue will increase so the firm can sell less products to cover their costs.

  19. How a firm can improve the BEP • Increase the price of the product. The firm will receive more revenue and will have to sell less products in order to break even. 2. Decrease the fixed or variable costs. The total costs will then be lower so the firm will have to sell less products in order to break even.

  20. Break Even: Exam Example A café has fixed costs of £5,000 per month. The variable costs are £5 per item and the selling price is £10. • What is the BEP? 3 marks • £5,000 / £5 = 1,000 2. If the fixed costs rose to £6,000, what would be the effect on the break even point for the firm? 3 marks • BEP would be higher – have to sell more products in order to break even • BEP would be 1,200 (£6,000 / £5 = 1,200) • If the fixed costs stayed at £5,000 but the variable cost rose to £6 per item, what would be the effect for the firm? 3 marks • BEP would be higher – have to sell more products in order to break even • BEP would be 1,250 (£5,000 / £4 = 1250) • If the fixed and variable costs stayed the same and the price rose to £15 per item, what would be the effect on the firm? 3 marks • BEP would be lower – have to sell less in order to break even • BEP would be 500 (£5,000 / 10 = 500)

  21. Examination Question WDP Ltd has fixed costs of £2,000 per month. They sell professional websites for £1,000 and their variable cost per website is £500. • How many websites must they sell each month to break even? Show your calculations • If the fixed costs rose to £2,500 per month, what would be the effect on the break even point? Explain in words and show your calculations • Presuming that the fixed costs remained at £2,000 and the variable costs remained at £500, explain how WDP Ltd could lower their break even point. Explain in words and give an example

  22. Pass the Buck: I will give you a topic. In turn, each member of your team must write down TWO things about the topic. Fold the paper over and pass the paper to the next person in your team – they then write down TWO things. You get a point for every different issue you write down.

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