Breakeven Analysis

Introduction

• Break-even analysis is based on categorizing

production costs between those which are
"variable" (costs that change when the
production output changes) and those that are
"fixed" (costs not directly related to the volume of
production).
• Total variable and fixed costs are compared with
sales revenue in order to determine the level of
sales volume, sales value or production at
which the business makes neither a profit
nor a loss (the "break-even point").
 Break-Even Analysis
• Importance of Price Elasticity of Demand:
• Higher prices might mean fewer sales to break-
even but those sales may take a longer time to
achieve.
• Lower prices might encourage more customers
but higher volume needed before sufficient
revenue generated to break-even
 Break-Even Analysis
• Links of BE to pricing strategies and
elasticity
• Penetration pricing – ‘high’ volume, ‘low’ price –
more sales to break even
• Market Skimming – ‘high’ price ‘low’ volumes –
fewer sales to break even
• Elasticity – what is likely to happen to sales
when prices are increased or decreased?
 Break-Even Analysis
TheAs Break-even
output is point
Costs/Revenue Total
The revenue
Thewhere
totaltotal
lower is
costs
the
TR TR TC occurs
generated,
Initially a by
determined
therefore
the
firmthe
price,
revenue the
equals less
total
VC costs
firm
price will
incurincur
willcharged
(assuming
– the firm,
fixed
and
in
steep
variable
thecosts, the total
costs do– –
thesesold
quantity
this accurate
example
these vary would
revenue
not depend
again this
haveforecasts!)
to sell curve.
Q1will on
to be
directly with by the
output or sales.
determined
generate sufficient
is
the
sum
amount
expected of produced
FC+VC
forecast
revenue to cover its
sales
costs. initially.

FC

Q1 Output/Sales
Costs/Revenue
Break-Even Analysis If the firm chose
TR (p = 3) TR (p = 2) TC to set price higher
VC than 2 (say 3) the
TR curve would
be steeper – they
would not have to
sell Q2 units to
break even

FC

Q2 Q1 Output/Sales
 Break-Even Analysis
TR (p = 1)
Costs/Revenue If the firm chose
TR (p = 2)
TC to set prices lower
VC (say 1) it would
need to sell more
units before
covering its costs

FC

Q1 Q3 Output/Sales
 Break-Even Analysis
TR (p = 2)
Costs/Revenue TC
Profit VC

Loss
FC

Q1 Output/Sales