Break even

Chapter

5

Break-even analysis
(CVP analysis)

1

5.1

Introduction

Cost-volume-profit (CVP) analysis looks at how profit changes when there are changes in
variable costs, sales price, fixed costs and quantity.

It is a good example of what if? analysis and it in part icular looks at sales minus variable
costs which is known as contribution. It allows management to understandthe level of sales
needed to cover all costs of a project and what level of sales is needed start making profits.
To break even would mean an organisation would be earning no profit and no loss.
Sales revenue = All variable and fixed cost
Main assumptions in this model are that selling price, fixed costs and variable costs are
constant.
5.2

Formulae to learn

Contribution per unit =sales price per unit less variable cost per unit
Break-even volume

=

Fixed overhead
Contribution per unit

The number of units you would need to sell in order to earn enough contribution to cover the
fixed overhead e.g. the number of units sold where the contribution would equal the fixed
overhead.
The contribution to sales ratio (C/S ratio)
The contribution to sales (or C/S) ratio(also called the profit-volume or P/V ratio) would
calculate how much contribution a product would earn for every £1 of sales generated,
expressed as a decimal or percentage. For example a 0.4 or 40% C/S ratio, would mean 40
pence of contribution is earned for every £1 of sales generated.
C/S ratio

=

Contribution per unit
Sales price per unit

C/S ratio

=

Total contribution
Totalsales revenue

2

Break-even revenue
The sales revenue earned that would give no profit and no loss. It can be calculated by
multiplying the break-even volume (above) by the products selling price, or alternatively by
using the fo llowing formulae.
=

Fixed overhead
C/S ratio

Margin of safety
Measures the sensitivity of the budgeted sales volume compared with the break-even salesvolume. The difference between the level of sales activity achieved and the level of sales
activity required to break-even in absolute or percentage terms.
Margin of safety (units) =
Margin of safety (%)

=

Budgeted sales volume less Break-even sales volume
Budgeted sales less Break-even sales volume x 100
Budgeted sales volume

Number of units sold to achieve a target profit
=Fixed cost + Target profit
Contribution per unit

3

Break-even charts
Indicates graphically profit and losses at different levels of sales volume achieved.

Cost and
revenue £
Sales revenue
Total costs
Variable costs
Fixed costs
Margin
of
safety

0

Breakeven
point

Budgeted
or actual
sales

Output (units)

·

Where sales revenue is greater than total cost it meansthat profits are being
generated.

·

Where sales revenue is less than total cost it means that losses are being incurred.

·

Where sales revenue equals total costs (intersection of the sales revenue line and total
costs line) it means that no profit or loss is occurring. This is the break-even point.

·

Variable costs vary directly with output, as more output is produced then morevariable costs are incurred.

·

Fixed costs do not vary with output and are constant for a range of output produced.
They are incurred even when there is no output at the beginning of production. This is
because they are costs that must be incurred to support manufacture such as
machinery or a warehouse.

·

The total costs line is a representation of the combined variable and fixedcosts. This
is why at nil output it has a cost which represents fixed costs, and then as output
increases the total cost line varies with it and in parallel with the variable cost line.

·

The margin of safety is the extra amount of sales that is expected to be generated
when the budget or actual sales is compared to the break even level of sales.

4

Profit volume charts
A variation...