- Income/revenue – These both mean the same thing. They are the total amount of money a business receives from their customers.
- Expenditure/costs – These are the total amount of money spent, e.g. to suppliers, on staff (wages) and for other requirements.
- Profit – A business makes a profit when income is higher than expenditure.
This is an example of a break even chart and the way it should look. As you can see the lines 0A represent the variation of income of different levels of production activity. The lines OB represent the fixed costs in the business. As the output increases, the variable costs are incurred, this means that the total costs also increase.
Fixed costs:
Fixed costs are business costs which are not directly related to the level of production or output. Therefore if the fixed costs of producing 100 items are £100, the costs of producing 150 items are also £100.
Nearly all expenses of running a business are fixed and do not alter when production levels change. If the rent of a factory is £5000 a year, it does not matter how many items are produced, the rent will not change and will always stay the same.
Example of fixed costs:
- Rent
- Wages
- Heating
- Electricity
- Insurance
- Advertising
How break even can be calculated:
The break even point can be calculated by means of a formula and also by the construction of a break even chart.
Sales for break even = fixed costs / selling price per unit – variable cost per unit
Example of break even:
The variable cost for making one burger is £0.97
The fixed costs of making burgers for 18 months will be a total of: £140.000
The expected unit sales of 150,000 burgers for 18 months
The unit price of the product is £1.99
With expected unit sales of 150000, £13,000 profit is made.
b)
E.g. 1 – Numerical example of break even
Lawnmower business
The figures used for both selling price and variable cost are both per unit.
Lawnmowers are brought for £50 (Variable cost) and are to be sold at £80 each.
The fixed costs for the business are 2,000.
So these figures would go into the formula as follows:
Sales for break even = £2,000/£50-£20 = £2,000/£30 = 66.666 (67 units)
c)
A break even chart for Mr Hatzis kebab van:
Mr Hatzis says his fixed costs are £400 per month, his variable cost per kebab is 80p, his selling price is £1.60, and he thinks on average he should sell 1000 kebabs per month. Below I am showing Mr Hatzis what his break even point is:
i) I have changed the expected unit sales to 300, to show Mr Hatzis what his break even point would be and also the profit and the loss he would make:
Mr Hatzis break even point is at 500 units. He has also made a loss of £160
ii) I have changed the expected unit sales to 800, to show Mr Hatzis what his break even point would be and also the profit and the loss he would make:
Mr Hatzis break even point is at x 500 units. He has also made a profit of £240 at 800 units sold.
Margin of Safety:
This is sometimes called the safety margin. This can be measured when the level of sales is above the break even point, basically when the business is profitable. The margin of safety is the number by which sales would have to fall before the break even point is reached.
Going back to my example of the lawnmower business I have mentioned, if the sales were 85 then the margin of safety would be:
85 – 67 = 18
If Mr Hatzis was to sell 1000 kebabs, his margin of safety would be:
1000-500 = 500 units
d)
I am carrying out the same calculation of break even, but using the formula method instead of the chart to show Mr Hatzis how this is done:
Sales for break even = £400 / 0.80 = 500units
e)
I am going to use actual sales figures from Mr Hatzis’s first month of trading, with sales of 700 kebabs.
- Reduced the selling price to £1.50 per kebab.
Total revenue = £1050
Total cost = £960
Profit = £90
- Cut overheads down to £200
Total revenue = £1120
Total cost = £760
Profit = £360
