6.3a Break-even

What is Break-even?

When revenue and costs are the same.

The business is not making a profit or a loss.

Example:

You buy a pack of five chocolate bars for £1
You sell each one for 20p each
You are left with the same amount of money as you started with

A business needs to know at which point it will break-even.

If it sells less than its break-even amount, it will make a loss.
If it sells more than its break-even amount, it will make a profit.

This is called the break-even point.

Break-even chart

Businesses can use the chart to estimate changes to profit by changing values. For example, how will profit be affected by increasing sales or changing the selling price?

x/x

Margin of Safety

A business needs to know what the difference is between the break-even point and their current output.
It allows a business to work-out how far its sales can fall before it hits break-even and then makes a loss.
This is called the margin of safety.

Pros and Cons of Break-even Analysis

Advantages

Quick and easy to work-out and visualise
"What if?" analysis is quick and easy (a business can see how changing revenue or cost values will affect profit and loss)
Allows planning of production volumes

Disadvantages

Assumes all manufactured products will sell
Becomes complicated if a business sells products at different prices / costs
Is not a sales forecast
Is only as good as the data provided (but this is true of all analysis!)