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Break-even Analysis

Break-even Analysis. Use quantitative & graphical methods to calculate break-even quantity. Define & interpret the margin of safety. . What is Break-even?. Total Costs = Total Revenue Measure of quantity How many units need to be sold in order to cover all product costs?

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Break-even Analysis

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  1. Break-even Analysis

    Use quantitative & graphical methods to calculate break-even quantity. Define & interpret the margin of safety.
  2. What is Break-even? Total Costs = Total Revenue Measure of quantity How many units need to be sold in order to cover all product costs? Key objective for new businesses Important for monitoring “product” cash-flow Money coming in (revenue) Money going out (costs)
  3. 5/7 Warm –up Explain the concept of Contribution Define and explain how is it calculated Describe how a business can improve its contribution.
  4. Contribution Revenueremaining after deducting direct/variable costs Amount “contributed” towards paying indirect & fixed costs Per Unit Contribution (Contribution_Margin) Average Revenue Average Variable Cost (Contribution_Margin * Units Sold) Total Contribution Total Fixed Costs Total Profit
  5. Strategies toIncrease Profitability? Increase Contribution  Increase in Profitability Increase Average Revenue Decrease Average Variable Cost Per Unit Contribution (Contribution_Margin) Average Revenue Average Variable Cost Total Contribution Total Fixed Costs Total Profit
  6. Purpose of Break-even Analysis To inform management Is it worthwhile to produce a good or service? How much profit will we earn if things go as planned?
  7. Determining Break-even(1) Formula Jeans Retailer Fixed Costs = $2,500 per month Average Selling Price = $30 Variable Costs = $10 Total Fixed Costs Total Variable Costs Total Revenue
  8. Determining Break-even(2) Interpret Chart Costs & Revenue ($) Jeans Retailer Fixed Costs = $2,500 per month Average Selling Price = $30 Variable Costs = $10 Total Revenue Total Costs 3750 2,500 Total Fixed Costs 125 Output/Sales (jeans/month)
  9. Margin of SafetyQuantifying Level of Risk Forecasted Demand Quantity – Break-even Quantity Large positive difference  less risk (“safer”) Small positive difference  riskier (“closer” to losing money) Negative  losing money
  10. Constructing Break-even Chart Calculate the break-even quantity (beq) Calculate the value ($) of total costs & revenue at break-even quantity TotalCostsbeq = (beq * AvgVarCost) + FixedCost TotalRevenuebeq= beq * AvgRevenue Label the x- & y- axis Draw & label the Total Fixed Cost (TFC) line Draw & Label the Total Cost (TC) line Crosses vertical axis at same level as TFC Draw & Label the Total Revenue (TR) line Begins at the origin
  11. Break-even Analysis & Decisions Evaluate new products Assess level of risk involved for a project Make or buy Cost structures are different Special Order Decisions Assess profitability of customer requests
  12. Break-even Calculate the total costs per month for the business. Calculate the firm’s profit for the month. Calculate the average cost of production at; 100 units 200 units Calculate the break-even quantity Wallets-R-Us Ltd. Has fixed overheads of $500 and sells 200 units per month. Each item sells for $35 and has direct/variable costs of $15.
  13. Break-even Calculate the firm’s current average costs each month. Calculate the firm’s break-even. Calculate the firm’s margin of safety. McMahon Candies has monthly fixed costs of $3,000 and unit variable costs of $2. Its current level of demand is 3,000 units each month. The average unit selling price is $6.
  14. Break-even Calculate the average selling price. Calculate the average variable cost per unit. Calculate the break-even level of output Calculate the margin of safety if 600 units per month are sold. Draw a break-even chart for Smash Racquets. Co. Smash Racquets Co. makes a profit of $10,000 on sales revenue of $50,000. Its fixed costs are $5,000 and sales volume is 1,000 units per month.
  15. Textbook Problem 5.3.3 pg 647
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