Break-Even Analysis Further Uses

1. Break-Even AnalysisFurther Uses Unit 5 Operations Management

2. Learning Objectives • HL – Use these methods to analyse the effects of changes in price or cost on break even , profit and margin of safety • HL - Calculate the required output level for a given target revenue or profit • Analyse the assumptions and limitations of break even analysis

3. HL Break Even Analysis • Can also be used to assist managers in making key decisions • Charts can be redrawn showing a potential new situation – this can then be compared with the existing position of the business • 3 examples of further uses of break even technique

4. HL 1. A marketing decision • Impact of the price increase, this will raise the sales revenue line at each level of quantity sold

5. HL Sales Revenue 2 Costs and sales revenue Sales Where is the new break even? 0 Full Capacity Units of output

6. 2. An operations management decision • Purchase of new equipment with lower variable costs, this will lower the variable cost line at each level of quantity HL

7. HL Costs and sales revenue Sales Total cost 2 Fixed costs 2 0 Full Capacity Units of output

8. HL 3. Choices • Choosing between 2 locations for a new factory – with different fixed and variable costs

9. HL Target Revenue and Profit • Adapted version of the break even formula can be used if the business wants to determine a target profit level and establish the level of output required to achieve it • Formula changes to Fixed costs + target profit Target profit level of output = Contribution per unit If the target profit is $25,000, fixed costs are $200,000 and contribution per unit $50 Level of output needed to earn the target profit is

10. HL Break Even Revenue • The amount of revenue needed to cover both fixed and variable so that the business breaks even

11. An evaluation – Usefulness • Charts are relatively easy to construct and interpret • Useful guidelines to management on break even points, safety margins and profit / loss levels at different rates of output • Comparisons can be made between different options by constructing new charts to show changed circumstances • Equation produces a precise break even result • Can be used to assist managers when taking important decisions

12. An evaluation - Limitations • The assumption that costs and revenues are always represented by straight lines is unrealistic TC SR FC BE1 BE2

13. An evaluation - Limitations • Not all costs can be conveniently classified into fixed and variable costs (semi – variable costs) • No allowance for stock levels, break even chart assumes all units produced are sold

15. (iii) Evaluate the usefulness of using break even charts (8)

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