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Break-Even AnalysisFurther Uses
Unit 5 Operations Management
Learning Objectives
HL – Use these methods to analyse the effects of changes in price or cost on break even , profit and margin of safety
HL - Calculate the required output level for a given target revenue or profit
Analyse the assumptions and limitations of break even analysis
Break Even Analysis
• Can also be used to assist managers in making key decisions
• Charts can be redrawn showing a potential new situation – this can then be compared with the existing position of the business
• 3 examples of further uses of break even technique
HL
1. A marketing decision
• Impact of the price increase, this will raise the sales revenue line at each level of quantity sold
HL
Units of output
0
Cost
s an
d sa
les
reve
nue
Sales
Full Capacity
Sales Revenue 2
Where is the new break even?
HL
2. An operations management decision
• Purchase of new equipment with lower variable costs, this will lower the variable cost line at each level of quantity
HL
Units of output
0
Cost
s an
d sa
les
reve
nue
Sales
Full Capacity
Fixed costs 2
Total cost 2
HL
3. Choices• Choosing between 2 locations for a new
factory – with different fixed and variable costs
HL
Target Revenue and Profit• Adapted version of the break even formula
can be used if the business wants to determine a target profit level and establish the level of output required to achieve it
• Formula changes to
Target profit level of output =
Fixed costs + target profit
Contribution per unit
If the target profit is $25,000, fixed costs are $200,000 and contribution per unit $50Level of output needed to earn the target profit is
HL
Break Even Revenue
• The amount of revenue needed to cover both fixed and variable so that the business breaks even
HL
An evaluation – Usefulness
• Charts are relatively easy to construct and interpret• Useful guidelines to management on break even
points, safety margins and profit / loss levels at different rates of output
• Comparisons can be made between different options by constructing new charts to show changed circumstances
• Equation produces a precise break even result• Can be used to assist managers when taking
important decisions
An evaluation - Limitations
• The assumption that costs and revenues are always represented by straight lines is unrealistic
BE1 BE2
TC
SR
FC
An evaluation - Limitations
• Not all costs can be conveniently classified into fixed and variable costs (semi – variable costs)
• No allowance for stock levels, break even chart assumes all units produced are sold
(iii) Evaluate the usefulness of using break even charts (8)
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