Unit 3Financial Forecasting

in Business

P4 P5 M2 D1Break Even

P4 P5 M2 D1

The Break Even PointThe Break Even PointThe number of cakes Max needs to sell

in order to pay all the costs of running his business.

Why calculate the break even point?

• So Max knows how many cakes he has to sell each year in order for the business to survive

• Once he has reached his break even point, he then knows all sales after that will be profit.

P4

Constructing a Break-Even Constructing a Break-Even ChartChart

£

Output

Salesrevenue

TotalCosts

Fixed Costs

Break-evenPoint

Margin of Safety

Number of Units 0 2 4 6 8

Fixed Costs

Variable Costs

Total Costs

Sales Revenue

Break-even Table: based on a price of £2000

Fixed costs are £4000, the variable cost per unit is £1000

4000 400040004000 4000

0

600040002000

4000

8000

80006000

8000 12000 16000

10000 12000

0

4000

Break-Even Chart: Price Break-Even Chart: Price £2000£2000£

Revenue

Number of cakes

Salesrevenue

TotalCosts

Fixed Costs

Break-evenPoint Profit if we sell

6 units = £2000

2 4 6 8

8000

6000

4000

2000

14000

10000

Loss if we onlysell 2 units = £2000

Break evenPoint =4 units

12000

16000

Number of Units 0 1 2 3 4

Fixed Costs

Variable Costs

Total Costs

Sales Revenue

Break-even Table: based on a price of £3000

Fixed costs are £4000, the variable cost per unit is £1000

4000 400040004000 4000

0

300020001000

4000

4000

60005000

6000 9000 12000

7000 8000

0

3000

Break-Even Chart: Price Break-Even Chart: Price £3000£3000£

Revenue

Number of cakes

Salesrevenue

TotalCosts

Fixed Costs

Break-evenPoint

1 2 3 4

6000

3000

9000

12000

Break evenPoint =2 units

Margin of Safety (1 cake)

What happened to the break-even point when Max

increased his price from £2,000 to £3,000?

Break-even point fell from 4 to 2. He did not have to

sell as many cakes in order to break even.

Now draw a break even graph using the

figures from the Max’s Cartoon Cakes.

P5

Break Even Graph: Max

Fixed costs per year: £7920Price per cake: £7.50Variable cost per cake: £3.79Plot:Fixed costsTotal costsSales RevenueLabel BEP: where sales revenue crosses

the total costs line

P5

Break Even Graph: Max

500 1000 1500 2000 2500 3000

FC

VC

TC

SR

7920 7920 7920 7920 7920 7920

1895 3790 5685 7580 9475 11370

9815 11710 13605 15500 17395 19290

3750 7500 11250 15000 18750 22500

Break-Even Chart: Price Break-Even Chart: Price £7.50£7.50£

Revenue

Number of cakes

Salesrevenue

TotalCosts

Fixed Costs

Break-evenPoint

Break evenPoint =?? units

Margin of Safety (??? cakes)

500 1000 1500 2000 2500 3000

5000

10000

15000

20000

25000

Margin of Safety

The difference between the number of cakes Max would like to produce and sell, and the break even point. Max thinks he will sell 2160 cakes every year.

Margin of Safety for Max:

2160 – Break Even Point = ?

P5

Break Even Report

Follow the format on your worksheet.

Before Question 4, put a heading:

a) Graph

P4

Calculating the break-even point without a graph

Calculating how many products we need to sell in order to break even and cover our costs.

Formula:

Fixed CostsContribution (Price – Variable cost)

P4

Use the break-even formula to work out the break-even point for questions 1-5 below

Fixed CostsContribution (Price – Variable cost)

1. 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

26,000 / 2,000 = 13

10,000 / 2,000 = 5

50,000 / 10,000 = 5

1,000 / 500 = 2

Using “P4 Break Even Calculation

Worksheet.doc”, calculate the break even points.

Complete the calculation at the bottom of the page for Max’s Cartoon Cakes.

P4

Using the Break Even Formula

Fixed CostsPrice – Variable Cost

1. 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

50,000 / 2,000 = 25

10 / 2 = 5

260 / 20 = 13

1,000 / 200 = 5

P4

Break Even Report

b) Using a Formula

• What is the formula used to calculate the break even point?

• Show the calculations for Max• What is Max’s break even point using the

formula• Compare this to your graph – which

calculation do you think is more accurate and why?

P4

Revision of Break Even1. Costs that do not change with output are called?2. Flour, eggs and cream are examples of which type

of cost?3. Which two lines cross on a break even graph to

show the break even point?4. How do you calculate total costs?5. Sales revenue = Number of cakes sold x ?6. The difference between the number of cakes

produced and the break even point is called?1. Fixed2. Variable3. Sales revenue and total costs4. Fixed costs + Variable costs5. Price6. Margin of Safety

Demonstrate the impact of changing cost and

revenue data on the break even point of a selected

business.

M2

Complete the worksheet:“M2 Changing Cost Revenue on BEP

Worksheet.doc”.

Using the worksheet, write a report explaining the effect on

Max if costs and revenue change in his business. Show

all the calculations and figures. How can Max improve his break

even point?

M2

Formula to calculate the break even point

Fixed Costs

Price – Variable Cost

1. Calculation using the original figures

79207.50 – 3.79

1.Break Even Point

2135 cakes

2. Increase in Fixed Costs

Insert an increase in Fixed Costs:

£8000

2. Increase in Fixed Costs

Re-calculate the new Break Even Point.

Write down one reason for the possible change in the fixed costs.

Explain the impact on the break even point when the fixed costs increased.

3. Increase in Variable Costs

Insert an increase in variable costs:

£5.00

3. Increase in Variable Costs

Re-calculate the new Break Even Point.

Write down one reason for the possible change in the variable costs.

Explain the impact on the break even point when the variable costs increased.

4. Increase in Price

Insert an increase in variable costs:

£8.00

4. Increase in Price

Re-calculate the new Break Even Point.

Write down one reason for the possible change in the price.

Explain the impact on the break even point when the price increased.

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.

M2

How Max can improve the BEP

1. 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.

M2

The Impact of Changing Costs and Revenue on the Break Even Point for

MaxThe original break even point for Max was ………… cakes.

Increase in Fixed Costs

If Max increased his fixed costs to £8,000, the calculation for the BEP would be:

………………………………………

The new break even point would be: ……………

A possible reason for a change in the fixed costs is ...........................................

The impact on the BEP is that it has changed from ................to ................

To improve this BEP, Max will have to …………………………………………………………………

M2

Increase in Fixed CostsIncrease in Fixed Costs£Revenue

Number of cakes

Sales revenue

Total Costs

Fixed Costs

500 1000 1500 2000 2500 3000

5000

10000

15000

20000

25000

Fixed Costs

Total Costs

Increase in Variable CostsIncrease in Variable Costs£Revenue

Number of cakes

Sales revenue

Total Costs

Fixed Costs

500 1000 1500 2000 2500 3000

5000

10000

15000

20000

25000Total Costs

Increase in PriceIncrease in Price£Revenue

Number of cakes

Sales revenue

Total Costs

Fixed Costs

500 1000 1500 2000 2500 3000

5000

10000

15000

20000

25000

Sales revenue

How Max can improve the BEP

1. 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.

M2

The Importance of Break Even

Report must include:• Detailed explanation of the benefits

of break-even calculations – with examples

• Detailed explanation of the limitations of break-even calculations – with examples

• Overall, do you think Max should calculate the break even point? Give detailed reasons for your decision

D1

Benefits of Break Even

1. Know how many cakes need to be sold – give example

2. Know whether the business will make a profit or loss – give an examples

3. Can take action if he knows he is not on target to reach the break even point – give an examples

4. Can decide on his “margin of safety” – give an example

D1

Limitations of Break Even

• When his costs change so the BEP will change – give an example

• If he changes his price, the BEP will change – give an example

• The system presumes that the cakes will be sold. This may not happen – give an example

D1

Importance of Break Even:Conclusion

Overall, do you think Max should calculate the break even point? Using the work you have already written, give your opinion and fully justify your answer.

Consider:• Do the benefits outweigh the limitations?• Is it essential for Max to know how many cakes he

needs to sell to cover his costs?• What might be the consequences if he did not know

his BEP?• The graph is tricky to produce but the formula is

easy to use – Max could set this up on a spreadsheet

D1

Instructions for the spreadsheet

• Explain in your work that Max could use a spreadsheet to calculate his BEP

• Insert a screenshot of the spreadsheet showing the formula and label

• Insert a screenshot of the spreadsheet and label

• Change either the price, fixed cost or variable cost on the spreadsheet

• Insert a screenshot showing the change you made. Label the screenshot and explain what happened to the BEP.

• Summarise why using a spreadsheet is a good idea for Max

Work for Today …

• Complete D1 work including the instructions for the spreadsheet

• Load “Break Even Worksheet Table for Max.doc” from Unit 3

• Copy figures onto the table and replace with hand written copy in work.

• Design a title page for work: “Break Even”