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Break-Even Analysis TheAs Break-even

Total output
revenue
Thewhere is point
totaltotal is
costs
Costs/Revenue TR The
occurs lower the
TR TC generated,
Initially a by
determined
therefore
price,
revenue the
equals
the
firm
less the
total
VC firm
price
costs
will
willcharged
(assuming
– the
incur
incur fixed
firm, and
in
steep
thecosts,the
variable 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

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Break-Even Analysis
Costs/Revenue 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 as
many units to
break even

FC

Q2 Q1 Output/Sales

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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

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Break-Even Analysis
TR (p = £2)
Costs/Revenue TC
Profit VC

Loss
FC

Q1 Output/Sales

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Break-Even Analysis Margin of

TR (p = £3) TR (p = £2)
TC A higher
safety shows
Costs/Revenue
price
how farwould
sales can
VC fall before
lower
Assume thelosses
made. If Q1 =
break
current
1000 andeven
sales
Q2 =
point
1800, and could
at Q2sales the
margin
fall by 800ofunits
before awould
safety loss
would be made
widen

Margin of Safety
FC

Q3 Q1 Q2 Output/Sales

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Costs/Revenue
Eurotunnel’s
High initial FC.
FC 1
Interest on debt
problem
rises each year – FC
rise therefore
FC
Losses get
bigger!
TR
VC

Output/Sales

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Break-Even Analysis
• Remember:
• A higher price or lower price does
not mean that break even will
never be reached!
• The BE point depends on the
number of sales needed to
generate revenue to cover costs –
the BE chart is NOT time related!

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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

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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?

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