Finance and Accounting

3.3 Breakeven Analysis

Ms. Elaine B Gili

gilie@verdala.org
August 2017
 Extract from syllabus
Paul Hoang Ed 2 – Unit 5.3

SL TOO!
NEW
You need graph paper. Understood?

IB sample: (June 2013)

Fill it in with numbers like
the alarm clock style
 Graph RULES
1. Do not forget to label the graphs and the axis
2. Be neat and accurate
3. Always use graph paper
4. Get all your basic skills from maths
5. Careful when choosing your scale - keep it
simple e.g. divisable by 5, 25, 10, 100....NOT
by 8!!!
What is meant by Breakeven?
 What is meant by Breakeven?
• It is when a business neither makes a profit
nor a loss

• It is when profits = losses = zero

• That point when all expenses are just covered.

Let us get more technical..............

What is meant by Breakeven?
Total Revenue - Total Cost = zero

1,500 – 1,500 = 0 = BE

1,700 – 1,500 = 200 = Profit

1,500 – 1,700 = (200) = Loss

 Example 1
Here is the typical information you will be given:

▪ Maximum capacity = 9,000 units

▪ Selling price per unit = $10
▪ Variable cost per unit = $4
▪ Fixed costs = $24,000
 Plotting a whole exercise
• You need to figure out your y-axis and x-axis
• Prepare your workings for TR and TC.
• Plan an adequate scale.
• X-axis – look at the units given e.g. The maximum
capacity is 9,000 units is very important!
• Y-axis – (will explain this in the coming slides) find
the highest point which is: the maximum capacity
x SP per unit (the highest TR possible).
How do we find total revenue?

TR
 Total revenue
Total revenue = SP x no of units

SP = selling price per unit = e.g. $10

If we sell 0 units, the TR = $ 0

If we sell 3000 units, the TR = $ 30,000
If we sell 6000 units, the TR = $ 60,000
If we sell 9000 units, the TR = $ 90,000
 Plotting the TR graph
$ 000
90
TR

0 9
Units
000s
 Plotting the TR graph
1. It is a straight line
2. It always starts from 0,0
3. All you need is one other point to draw it!

+ the graph rules

How do we find total cost?
This is a bit tougher!

TC
 Total cost
Total cost is made up of two elements:

Total cost = T Fixed cost + T Variable cost

Any idea what they are?

 Total cost
Total cost is made up of two elements:

• Fixed costs – costs that do not vary with the level

of output e.g. Rent. They are usually given p.a.

• Variable costs – costs that vary directly with the

level of output e.g. direct material and direct
labour. These are usually given as e.g. $0.5 per
unit
 Fixed costs
Fixed costs are usally given as a lump sum per
annum e.g. $24,000 p.a. No matter how much we
sell or produce, this cost will not change.

If we sell 0 units, the FC = $ 24,000

If we sell 3000 units, the FC = $ 24,000
If we sell 6000 units, the FC = $ 24,000
If we sell 9000*units, the FC = $ 24,000
*maximum capacity
 Plotting the fixed cost graph
$ 000

24 FC

0 6 9
Units
000s
 Plotting the FC graph
1. It is a straight HORIZONTAL line
2. It always starts from the annual FC
3. You do not even need another point to draw
it!

+ the graph rules

 Variable costs
Look out for:
direct material Interchanged
direct labour terminology
patents (rare) !!!!!!!!!!!!

Sum them up e.g.

Direct material is $ 1 per unit
Direct labour is $ 3 per unit
Total VC per unit is $ 4
 Total Variable costs
Total VC per unit is $ 4
Total variable costs = VC per unit x units

If we sell 0 units, the TVC = $ 0

If we sell 3000 units, the TVC = $ 12,000
If we sell 6000 units, the TVC = $ 24,000
If we sell 9000 units, the TVC = $ 36,000
 Plotting the total variable cost graph
$ 000
VC
36

0 9
Units
000s
 Plotting the TVC graph
1. It is a straight line
2. It always starts from 0, 0
3. All you need is just another point to draw it!
4. Just like the TR graph, but the TR graph has
different values.

+ the graph rules

 BUT
Total Cost =
Total Variable cost + Total Fixed Cost
 Total cost
• FC = $24,000
• VC = $ 4 per unit
• Choose any amount of units
• Input the units into the formula

TC = FC + (VC x units)
 Total cost
TC = FC + (VC x units)
0 units, TC = 24,000 + (4 x 0) = 24,000
3000 units, TC = 24,000 + (4 x 3000) = 36,000
6000 units, TC = 24,000 + (4 x 6000) = 48,000
9000 units, TC = 24,000 + (4 x 9000) = 60,000

To draw TC, just choose

one point from the above
 Plotting the total variable cost graph
$ 000 TC

TVC

24 FC

0
Units
000s
 Plotting the TC graph
1. It is a straight line
2. It always starts from FC, 0
3. All you need is just another point to draw it!
4. Just like the TVC graph, but it shifts upwards
by the FC value.

+ the graph rules

All together now...sing!
 TR
$ 000
TC

TVC
24 FC

0
Units
000s
At home, try to plot everything
from scratch to make sure you
know what you are doing!
Graphs grasped, let us move to
some more formulas.........
 Breakeven is where
Total Revenue = Total Cost

or when we neither
have a profit nor a loss
 TR
$ 000
TC
BE

0
? Units
000s
 Finding the BE number of units
1. TR - TC = 0
2. TR - (FC + TVC) = 0
3. TR - FC - TVC = 0
If x is the no of units
4. SPx – FC – VCx = 0
5. SPx – VCx = FC
6. (SP – VC)x = FC
7. X = FC / (SP – VC)
8. X = FC / Unit contribution
 CONTRIBUTION PER UNIT
• (SP – VC) per unit is referred to as Contribution

• This stems from the concept: how much does

each unit sold contribute towards fixed costs?

• Once all FC are covered, the contribution goes in

favour of PROFITS.

FC / contribution per unit = BE units

 Finding the BE number of units
• FC $24,000
• VC $4 per unit
• SP $10 per unit
Formula: FC / (contribution per unit) = BE units
Formula: contribution per unit = (SP-VC) per unit
$24,000 / $(10-4)
$24,000 / $6
4000 units to BE...check it on your graph
 At BE (4000 units),
TR = TC
Prove it!
a) What is the TR when we sell 4000 units?

b) What is the TC when we sell 4000 units?

c) Is your answer correct on the graph?

 At BE (4000 units),
TR = TC
Prove it!
a) What is the TR when we sell 4000 units?
TR = SP x units = 4000 x $10 = $40,000
b) What is the TC when we sell 4000 units?
TC = FC + TVC = 24,000 + (4)(4000) = $40,000
c) Is your answer correct on the graph?
YES
 TR
$ 000
TC
BE
40

0
4 Units
000s
 Conclusion:
There are 3 methods to find the BE level

1. Graphical method

2. Using: TR – TC = 0 and open this up!

3. Using: FC/contribution per unit

Finding the profit or loss for any level of output:

At BE,
TR – TC = 0

But at all the other points,

TR – TC = profit or loss
 Check your knowledge:
a) What is the profit/loss when we sell 2000 units?

b) What is the profit/loss when we sell 6000 units?

Answer the above using both the formulas covered earlier

and the graph that you prepared.

Learn how to show the above information on the graph.

 Check your knowledge:
a) What is the profit/loss when we sell 2000 units?
TR = $10 x 2000 = $20,000
TC = 24,000 + (4) (2000) = 32,000
TR – TC = (12,000) LOSS
TR < TC = Loss
b) What is the profit/loss when we sell 6000 units?
TR = $10 x 6000 = $60,000
TC = 24,000 + (4) (6000) = 48,000
TR – TC = 12,000 PROFIT
TR > TC = Profit
 TR
$ 000 PROFIT TC
BE

LOSS

0
4 Units
000s
$ 000
TR
PROFIT TC

BE

LOSS

0
2 4 6 Units
000s
The Margin of Safety

Ever heard this term?

 The Margin of Safety:
• This refers to the cushion we have available before we
experience losses.

• By how much should sales fall before we are really in

trouble?

• Formula: Current output less BE level

• You can give it:

– in units
– in %
– or graphically
 You can give it:

TR 1. in units
(3000 units)
$ 000
2. in a %
BE TC (3000 /7000)
40 = 43%

3. or graphically
Margin
of safety

0
4 7 Units
Current
output 000s
 CW SL & HL
1. GPPB page 33, SL P2 May 2005 – Heroes Taxis

2. GPPB page 43, SL P2 Nov 2005 – Ganstoni

Enterprises (part b is a HL extension – I
challenge you to try it too!!!)

3. online quiz - link on mb - http://www.tutor2u.net/business/quiz/basics-

breakeven/quiz.html

4. Light Pink page 56 & 58

 Heroes Taxis workings
SP = $40 per customer
VC = $8 per customer
FC = $416 per week

X axis – up to 115 customers;

Y axis = highest TR = 115 x 40 = $4600

BE level = $416 / $(40-8) = 416/32 = 13 customers

Margin of safety at 115 customers = 115-13 = 102 customers

P/L at 25 customers: P/L at 115 customers:

TR = 25*40 = $1000 TR = 115*40 = $4600
TC = 416 + (8*25) = $616 TC = 416 + (8*115) = $1336
Profit = 1000-616 = $384 Profit = 4600-1336 = $3264
Heroes Taxis part (b)
 SL reinforcement
HW graded: Light Pink PPB pages: 56

SL you are not FREE yet but still

work as many as you can!!
• GPPB pages: 33, 43, 70, 96
• Light Pink PPB pages: 56 , 58, 39, 49, 74
Breakeven Limitations
Can you think of any?
 Breakeven Limitations
• The graphs are not so linear in real life.

• The business could be selling more than one product.

• Any opening and closing stocks are ignored. We are assuming sales =
production/purchases.

• BE charts are static – they do not reflect a changing external

environment e.g. Changing taxes, tastes, seasons, exchange rates....

• There are a lot of estimates.

• Qualitative factors are ignored.

• Some costs are neither fixed nor variable but semi-variable.

 Change in syllabus May 2016
• The upcoming sections used to be HL only
• This is no longer the case
• There are no SL past papers available with
these additional aspects
• So to be safe, SL will work HL examples.
 Paul Hoang pages 563/4

Breakeven Limitations
Read both pages at home as reinforcment
 Changes in Breakeven
- Even FC could change over time.
- VC per unit or SP per unit could change too.
- Nowadays, with software applications these
changes are so much easier to reflect on a BE
chart.
- You are not that lucky, and you will have to show
all the workings.
 Paul Hoang 1 ed
Pages 648/649…next slide

Changes in breakeven
Try exercises as CW:
▪ 5.3.4
▪ 5.3.5
 Paul Hoang example
Part 1 1) Find the MOS
2) Find the BE
SP - 20 3) Prepare a chart
VC - 5
FC - 3,000 per month
Output – 500 customers
Max output – 600 customers
 5.3.4 part 1
Sp = 20
VC = 5
FC = 3000
Output = 500
Max capacity = 600

1. BE Qty = FC / cont per unit = 3000/(20-5) = 3000/15 = 200 units

2. Margin of safety = 500-200 = 300 units

3. To draw it e.g. using 500 units:

– TR = 500*20 = 10,000
– TC = 3000+(5*500) = 5,500
 Paul Hoang example
Part 2 1) Find the new BE
Rent will increase to 4,000 2) On the same BE chart
SP to fall to 17 show the new BE (use a
Output = 520 clients different colour)
3) Was the change in price
a good decision.
 5.3.4 part 2
Sp = 20 to 17
VC = 5
FC = 3000 to 4000
Output = 500 to 520
Max capacity = 600

New BE qty = 4000/(17-5) = 4000/12 = 333.333 but round it always to 334 units
On the SAME BE chart reflect the change in FC (TC graph) and SP (TR graph)
$ 000 TR
TR1
TC1
TC

0 200 334 Units

000s
Target profit and revenue

All you need is to be able to play

around with the formulas.
 Example
Using again:
FC = $24,000
VC = $4 per unit
SP = $10 per unit

If our target is a profit of $16,000, how many

units should be sold?
 Method 1
TR – TC = $16,000
...proceed and find x!
(SP.x) – (FC + VC.x) = 16,000
10x – 24,000 – 4x = 16,000
10x - 4x = 16000 + 24,000 = 40,000
6x = 40,000
X= 40000/6 = 6,667 units
EASY NO?
 Method 2
For a profit of $16,000, you need to earn
enough contribution to cover:
FC of 24,000 + Profit of 16,000
(FC + Profit) is known as TOTAL contribution

1 unit = $6 contribution
X units = $40,000 contribution
$40,000/$6 = 6,667 units
 Reinforcement
BPPB pages: 55 (CW)

• Try parts a (i) and a (ii)

• Start brainstorming parts (b) and (c)
 BPPB page 55
• Read the question carefully
• Jot down all the figures given
• There are two businesses – Stay in Touch and Speedy
• Stay in Touch is thinking of stopping production and buying
the products ready made from Speedy.
• You need to consider:
– What Stay in touch is doing now
– What changes there will be for Stay in Touch if they use Speedy
– What changes there will be for Speedy if they sell to Stay in Touch
BPPB page 55 part a (i)
BPPB page 55 part a (ii)
BPPB page 55 part b

Part b Part c
 Financial part
– Always try to use numbers/figures to back up
your answer

– Compare the scenario before and after and find

(if applicable) the change in:

• Profit
• BE
• MOS
pto
BPPB page 55 part b – financial part
 Should Stay in Touch produce
or buy from Speedy?

Think about the non-financial aspects TOO.

Let us look at some ideas…
 NON Financial part
Here are some arguments you could use!

• Especially if it is working at full capacity:

• Stress on workers, de-motivation (later)

• No free machines to make up for any breakdowns

• Faster wear and tear of machines (depreciation). They

will need to be replaced faster!
Do you want this?
 NON Financial part (cont’d)
Ethical issues e.g. :
– exploitation of workers (bad conditions of work),
– child labour,
– dangerous materials
– safety issues
– Etc..
 NON Financial part (cont’d)
• Quality issues – especially if subcontracting!
 NON Financial part (cont’d)
• Price discrimination – reaction of customers

• Diseconomies of scale, e.g. HR issues

• Media issues – reputation/image

• Trade unions if workers will be fired

 NON Financial part (cont’d)
• Are there any freed up resources?
Consider/highlight their alternative use.

• Sources of finance that might be needed for

an expansion and all the aspects we relating
to the various options available.

• Government reaction to the change

especially if workers will be fired
 NON Financial part (cont’d)
• Hiring and Training of new employees

• Dependence on another businesses or on a

major customer e.g. in Stay in Touch’s dependence on
Speedy

• Have any other options available been

considered?

• External environment scenario e.g. in Paolo’s Pasta

sales are falling!
 CONCLUSION
• Use the information in the case study

• Balance your answer between pros and cons

• If it is an evaluate, you need to take a

decision
 Now try answering
the BPPB page 55 part b

(stay in touch and speedy)

 BPPB
page 55
part b
BPPB page 55 part c
 Reinforcement
• nov 2014 HL P2
• may 2015 HL P2
• nov 2014 SL P2
• may 2014 SL P2
• nov 2015 SL P2
• may 2016 SL P2 - parder(done)
• BPPB pages: 55 (done), 81/2, 126a
• Dark Pink PPB pages: 40, 63, 73, 80
• IB Q bank – Aravand eye
Additional worked examples
WHOLEHEART BAKERY

BPPB page 81/2

 BPPB page 82 - QUESTIONS
i. Showing full workings calculate the total weekly profit/loss being made
by Wholeheart bakery at the present levels of output. (3)

ii. Calculate the change in profit/loss if Wholeheart Bakery accepts the

offer to manufacture exclusively for Max Mart. (1)

iii. What price per box would Wholeheart bakery need to charge Max Mart
to achieve the required 30% increase in profits over present levels?
Show your workings. (3)

iv. To what extent should the decision to accept or reject Max Mart order
be based on the financial data provided by the production manager? (6)
 BPPB page 81/2: Whole-heart bakery

Wholeheart Bakery Products for Max Mart

SP = $1.3 per unit SP = $1.1 per unit
VC = $0.4 per unit VC = $0.4 per unit
FC = $56,000
Current units = 60,000 Current units = 60,000
Future = 0 Future = 150,000 units
BPPB page 81/2
BPPB page 81/2
BPPB page 81/2
BPPB page 81/2
 Pink PPB page 73 - Part a
Define and add examples
 
Fixed costs are cost that do not change with the level
of output in a business e.g. Lease costs (they are
always $200/week irrelevant of amounts produced)

Variable costs are costs that DIRECTLY change with the

amount of units produced e.g. Raw materials, Wages
and Electricity/gas/water (in this case). You can
identify these costs as they are per unit (per KG)
 Pink PPB page 73 - Part a
SP - $7
Full capacity = 12000 units
Current capacity = 10000 units

FC - (200+300) per week = (500 x 52) = 26000 per annum (It is important to
change it to a year)*

VC – (1.25+1.60+0.15) = $3/kg

Use a reasonable level of units (I recommend that you use the current level
of output - 10,000 units)

*Mortgages are not expenses in the Trading & P&L and as such are not FIXED
COSTS!! However, the model answer takes them into account too. In that case FC
would have another (500*12) = 6000
Total FC would be $ 32,000 not $ 26,000. I will correct both answers.
Paolo’s Pasta – May 2007 Pink PPB page 73 part d
Current production 10,000 SP = $7/unit
Full capacity 12,000 ONLY FC = 26,000; VC = $3/unit
Hotel chain needs 4,000 SP = $4.5/unit

Current profit = $14,000

TR = 10,000 x 7;= 70,000 TC = (10,000 x 3) + 26,000 = 56,000

New Profit if we give all 4000 to the hotel:

8,000 units at a contribution of (7-3) = 8,000 x 4 = 32,000
4,000 units at a contribution of (4.5-3) = 4000 x 1.5 = 6,000
FC still 26,000 (excludes mortgages otherwise would be $32,000)
New Profit = (32+6)-26 = ONLY $12,000
or whatever other comparison!
LAST ONE!!! Pink PPB page 80