Business Opportunity• Lunchtime pitch for a sandwich stall

• Monday – Friday: 100 customers per day

• Average spend per person = £5

• Cost of production is about half the selling price

• Rent for the pitch

= £1000 per week

Should I do it?

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Break-even analysis

Definition

• Break Even is the point at which sales revenue is equal to total costs. It is the point at which the business is making neither a profit nor a loss.

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• So, break-even analysis tells a business how much it needs to sell to cover its costs

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Businesses incur two types of costs

• Fixed Costs are

• Variable costs are

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Businesses incur two types of costs

• Fixed Costs are the costs that do not change in-line with the number of units produced/sold.

• Variable costs are

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Businesses incur two types of costs

• Fixed Costs are the costs that do not change in-line with the number of units produced/sold.

• Variable costs are the cost that do change directly in-line with output.

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Break-even (the point at which a business is making neither a profit nor a loss!)

This is the formula to work out exactly how many units we need to sell to break even

Selling price - Variable costs = “Contribution”(per unit) (per unit)

Total fixed costs Contribution

“ContributionContribution” is the amount of money each unit is the amount of money each unit contributes towards the fixed costs of businesscontributes towards the fixed costs of business

= Break-even Point(the number of units needed to

break-even)

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For Example:• If a product sells for £15 and has variable

costs per unit of £11 what is its contribution?

• If the business has fixed costs of £20,000,how many units would it need to sell to break-even?

Each unit sold will make a contribution of £4 towards fixed costs of business.

£20,000 ÷ £4 = 5,000 units must be sold in order to break-even

So, 5,000 units = the “break-even point”

Break Even ExampleHackett’s Hair Salon

• Kenny Hackett runs a small but very fashionable hairdressing salon. His business has annual fixed costs of £54,000. Kenny has calculated that the cost of providing a standard cut, colour and style is £40.00 and he currently charges £100 for this service.

TASK: Complete the table on the handout then a draw break even chart

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Break Even Chart

Sales Revenue

TOTAL COSTS

Variable costs

Fixed Costs

The break even point

£ sa

les/

cost

s

Number of units

Hackett’s Hair Salon

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Break Even Point

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Importance of Break-even analysis

• Contribution from every unit sold above the breakeven point adds to profits

• Breakeven point can provide a target for a business to exceed

• It helps to work out whether forecasted sales will produce a profit and whether further investment in product is worthwhile.

Limitations of Break-even analysis

• Does not take into account possible changes in costs over time period

• Does not allow for changes in selling price

• Analysis is only as good as the quality of the information used

• Does not allow for changes in market conditions – e.g. entry of new competitor

Structure for Break Even content of P6

• Define break even and explain how this tool can be useful when running a business.

• Explain how it can be a useful step in the budgeting process:– Setting sales targets– Setting targets related to costs– Helping to decide if a proposed deal is good

• Demonstrate the calculation of the BEP for Eco Clothing Ltd. (show formula and working from class)

• Include the BE table you produced (include the graph you produced as ‘Appendix A’)