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GCSEBusinessOCRRevision Notes5. Finance5.4 Break-EvenThe Importance of Break-Even

The Importance of Break-Even (OCR GCSE Business): Revision Note

Exam code: J204

Lisa Eades

Written by: Lisa Eades

Reviewed by: Steve Vorster

Updated on

The Concept of Break-Even

  • Break-even analysis is a financial tool used to determine the number of units a business must sell to reach a point where its revenue equals its expenses (neither profit nor loss)

    • It helps businesses understand the minimum level of sales or output they need to achieve in order to cover all costs

    • This helps business managers make informed decisions about pricing and production volumes

The main components of break even analysis include variable costs, fixed costs, and revenue
Variable costs, fixed costs and sales revenue are all used in calculating the break-even point 

  • Fixed costs are costs that do not change regardless of the level of production or sales

    • They remain the same at every level of output

      • E.g. Rent, salaries and insurance

  • Variable costs are costs that vary with the level of production or sales

    • They increase in direct proportion with the level of output

    • E.g. Raw materials, direct labour costs, packaging and shipping costs

  • Total costs are the sum of fixed costs and total variable costs at a particular level of output, calculated using the formula

Total space costs space equals space Fixed space costs space plus space Total space variable space costs

  • Revenue is the money gained from selling products, calculated using the formula

Sales space revenue space equals space Selling space price space cross times space Number space of space items space sold

Calculating Break-Even

  • The break-even point is expressed as a number of units and is calculated using the formula:

space Break minus even space point space equals space fraction numerator Total space fixed space costs over denominator Selling space price space minus space Variable space cost space per space unit end fraction

Examiner Tips and Tricks

You should always round UP the outcome of the formula to the nearest whole unit.

Worked Example

Marlon's Burgers has the following financial information for the month of May.

 

£

Raw materials for each burger

2.10

Packaging for each burger

0.20

Fixed costs

 1 ,730

Selling price of each burger

4.95

(a) Using the information in the table, calculate the level of output required to break even in May. You are advised to show your workings. [3 marks]

Step 1: Calculate the variable costs per burger

Variable space cost space per space burger space equals space Raw space materials space plus space Packaging equals space £ 2.10 space plus space £ 0.20 space equals space £ 2.30 [1]  

Step 2: Substitute the values into the break-even formula

  Break minus even space point space equals space fraction numerator Total space fixed space costs over denominator Selling space price space minus space Variable space cost space per space unit end fraction equals space fraction numerator 1 comma 730 over denominator £ 4.95 space minus space £ 2.30 end fraction equals space fraction numerator 1 comma 730 over denominator £ 2.65 end fraction equals space 652.83[1]    

Step 3: Round up to the nearest whole unit

  • 653.83 is rounded up to 654

  • 654 burgers need to be sold in order to break even [1]

Interpreting Break-Even Graphs

  • A break-even chart is a visual representation of the break-even point in a graph

    • The chart can also be used to identify:

      • Profit or loss at different levels of output

      • The margin of safety, which is the difference between the actual level of output and the break-even point

  • Three lines are plotted on a graph with an x-axis labelled units and a y axis labelled costs/revenues

    • Fixed costs

    • Total costs

    • Revenue

  • The break-even point is the output level at which the revenue and total costs line intersect

Case Study

Vic's Vans is a small electric van rental business.

  • Variable costs are £7.60 per rental

  • Fixed costs are £8,000

  • The rental price of each van is £32 per day

Fixed costs, variable costs, total costs and revenue at different levels of output

Units

0

100

300

500

Variable costs (£)

0

760

2,280

3,800

Fixed costs (£)

8,000

8,000

8,000

8,000

Total costs (£)

8,000

8,760

10,280

11,800

Revenue (£)

0

3,200

9,600

16,000

This data is used to construct Vic's Van's break even chart:

Break even charts show fixed and total costs, revenue at different levels of output, illustrating elements such as the break even point and margin of safety
The break-even chart shows the break-even point, profit at a given level of output and the margin of safety  

  • Fixed costs do not change as output increases

    • They are represented by a horizontal line at £8,000 for all levels of output

  • Total costs are made up of fixed and variable costs

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

  • Revenue increases as output rises

    • The revenue line slopes upward more steeply than total costs, eventually crossing the total costs line

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

    • In this example, the break-even level of output is 328 units

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

    • In this case, the margin of safety is:

450 space units space minus space 328 space units space equals space 122 space units

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

    • At 450 units, the profit made is:

£ 14 comma 400 space minus space £ 11 comma 420 space equals space £ 2 comma 980

Examiner Tips and Tricks

You will not be required to draw a break-even chart in the exam but you could be asked to manipulate a diagram that has been provided

You could be asked to

  • Illustrate a change to the selling price, variable costs or fixed costs on the diagram

  • Mark the break-even point or margin of safety

  • Identify the amount of profit (or loss) made at a given level of output

  • Label elements such as axis names or cost/revenue curves

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    Author
    Reviewer
    Lisa Eades

    Author: Lisa Eades

    Expertise: Business Content Creator

    Lisa has taught A Level, GCSE, BTEC and IBDP Business for over 20 years and is a senior Examiner for Edexcel. Lisa has been a successful Head of Department in Kent and has offered private Business tuition to students across the UK. Lisa loves to create imaginative and accessible resources which engage learners and build their passion for the subject.

    Steve Vorster

    Reviewer: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.