Break-even Charts Advantages & Disadvantages
Advantages Quick and simple to produce. Can identify potential problems in production levels. Useful when asking the bank for a loan (shows the bank that the business is planning for the future). Enables managers to see the level of production needed to break even.
Advantages (continued) The chart allows managers to read off expected profit / loss for different levels of output. Helpful in modeling possible changes. Eg can see the effects of a change in fixed, or variable costs, or of price. Helps to identify the Margin of Safety (difference between sales and the break-even point).
Disadvantages The chart is merely a forecast for the future. There is no guarantee that the figures will prove to be correct. The chart assumes a single product at a single price. In reality firms may sell many different products at different prices (eg discounts for large orders).
Disadvantages The chart does not take into account qualitative and external factors like the behaviours of competitors & consumers. Assumes all goods manufactured will be sold. It is possible that this will not happen. Fixed costs are only fixed in the short term. In the long term output can only increase if a new factory is built (increases fixed costs).
Disadvantages (continued). Managers need to consider many other factors beside output. Maintaining quality, reducing waste, and promoting sales are examples of other important areas that need attention. Assumes costs and revenues are always drawn as straight lines. This is unlikely to be the case in reality (eg the cost of materials may change frequently, and increased sales may only be possible if price discounts are given).
Disadvantages (continued). • It assumes that all products produced are sold. This is not always the case as stock may go out of date or get damaged or stolen. • The chart is prepared for a given set of conditions. It cannot cope with sudden increases in wages / prices or technology. • The effectiveness of the graph is very dependent on the accuracy of the data used to construct it. 7
Disadvantages (continued). • We assume that the total cost and total revenue lines are linear (straight) – this may not always be the case. • Some fixed costs are “stepped”, i. e. they will change when they reach certain levels of production. 8