Break-even (Edexcel A Level Business): Revision Note

Using the contribution to calculate the break-even point

• The contribution value is used to calculate the break-even point

• The break-even point is where total revenue earned for a product is exactly equal to its total costs and where the business is making neither a profit nor a loss

• It is calculated using the formula

$\mathrm{Break}‐\mathrm{even}\mathrm{point}=\frac{\mathrm{Fixed}\mathrm{costs}}{\mathrm{Contribution}}$

• The break-even point is expressed in units (e.g. the number of scented candles)

• Identifying the break-even point allows a business to understand how many items it needs to produce and sell to cover all costs before it starts to make a profit

  • Each subsequent unit sold past this point will generate profit for the business

Margin of safety

• The margin of safety is the difference between the actual level of output of a business and its break-even level of output

• The margin of safety can be calculated using the following formula:

$\mathrm{Margin}\mathrm{of}\mathrm{safety}=\mathrm{Actual}\mathrm{level}\mathrm{of}\mathrm{output}-\mathrm{Break}‐\mathrm{even}\mathrm{level}\mathrm{of}\mathrm{output}$

Interpretation of break-even charts

• A break-even chart is a visual representation of the break-even point and is used to identify the following

  • Fixed costs, total costs and revenue over a range of output

  • The break-even point, where total costs are equal to revenue

  • The profit or loss made at each level of output

  • The margin of safety

An example break-even chart

Diagram analysis 

• Fixed costs do not change as output increases

  • A2B's fixed costs are £8,000, and these do not change whether the business produces zero units or 500 units

• Total costs are made up of fixed and variable costs

  • At zero units of output, they are made up exclusively of fixed costs

  • At 500 units, the total variable costs equate to £11,800

  • This line slopes upwards because total variable costs increase as output increases

• The revenue line also slopes upwards

  • At zero units of output, the revenue is £0

  • At 500 units, the total revenue equates to £16,000

  • Revenue will increase with the output

  • The line will slope more steeply than the total costs and will cross the total costs line at some point

• The point at which the total costs and the revenue lines cross is the break-even point

  • The break-even level of output for A2B is 324 units

• The margin of safety can be identified as the difference on the x-axis between the actual level of output (in this case, 450 units) and the break-even point

• The profit made at a specific level of output can be identified as the space between the revenue and total cost lines

  • In this instance, the profit made at 450 units of output is £14,400 − £11,250 = £3,150

Limitations of break-even analysis