GCSE Business Studies Unit 2 Developing a Business

GCSE Business Studies Unit 2 Developing a Business Break-Even

Learning Outcomes Students should be able to: • • • calculate break-even both graphically and by formula explain the significance of the break-even point distinguish between fixed and variable costs label a break-even chart analyse a break-even chart calculate the margin of safety and explain its significance for a business Images © thinkstockphotos. co. uk

Break-even • Break-even is the point where: – total sales revenue is the same as total costs – a business is neither making a profit nor a loss – if sales revenue is greater than the breakeven point the business will make a profit • Break-even can be calculated by formula or graph Images © thinkstockphotos. co. uk

Importance of Break-even • Shows the amount of goods needed to be sold in order to cover costs and go on to make a profit • Used to set the price of a product • Assesses the impact of planned price changes • Assesses how changes in fixed and/or variable costs may affect profit Images © thinkstockphotos. co. uk

Fixed Costs • do not change with output • have to be paid regardless of the number of items produced • examples of fixed costs include: – Rent – Rates – Insurance One thing to remember fixed costs can change. An example of this is if a firm decides to expand move to larger premises they will increased rent and rates Images © thinkstockphotos. co. uk

Variable Costs • do change with output • vary according to the number of items produced • examples of variable costs include: – Raw materials – Production wages – Transport of goods Images © thinkstockphotos. co. uk

Break-Even Formula Fixed Costs Contribution Selling Price per unit – Variable Cost per unit Images © thinkstockphotos. co. uk

Princess Pooches Emily plans to open her own dog grooming business, called Princess Pooches and has asked you to help her work out the breakeven point for her business. The fixed costs are £ 30, 000 per year, the selling price per unit is £ 40 and the variable cost is £ 15 per unit. Your task – Calculate the break-even point for Emily’s business. Images © thinkstockphotos. co. uk

Contribution Selling Price per unit – Variable Cost per unit £ 40 – £ 15 Contribution = £ 25 Images © thinkstockphotos. co. uk

Break-even Formula 30, 000 25 Break-even = 1200 dogs groomed per year Images © thinkstockphotos. co. uk

How to Draw a Break-even Chart Costs/ revenue (£) Fixed Costs Output (units) Images © thinkstockphotos. co. uk

Add Total Cost Line ts s o c l Tota Costs/ revenue (£) Fixed Costs Output (units) Images © thinkstockphotos. co. uk

Add Total Revenue Line Costs/ revenue Break-even point T l a t o e u en v e R s t s o c otal T (£) Fixed Costs Output (units) Images © thinkstockphotos. co. uk

Margin of Safety Costs/ revenue Break-even point l a t o T e u en v e R s t s o c otal T (£) Fixed Costs Margin of Safety Output (units) Current Output Images © thinkstockphotos. co. uk

Margin of Safety Current Output – Break-even Point Margin of safety if the difference between the breakeven point and the current level of output. It is a safe margin because the business will be making a profit, between these two point. Images © thinkstockphotos. co. uk

Princess Pooches Emily thinks she will be able to groom 1600 dogs per year. Calculate: • Her margin of safety • Her projected profit Images © thinkstockphotos. co. uk

Margin of Safety Current Output – Break-even Point 1600 – 1200 Contribution = 400 units Profit = Contribution x Margin of Safety Profit = 400 x 25 Profit = £ 10, 000 Images © thinkstockphotos. co. uk

What If. . . • Fixed costs are increased to £ 50, 000? • Variable costs per unit rise? – what will happen the fixed costs line? – which line will be affected? • What if selling price per unit changes? – What 2 lines will not be affected if the selling price changes? – So which line is left? Images © thinkstockphotos. co. uk

What If. . . Fixed costs are increased to £ 50, 000? Answer: both the fixed costs and total costs lines will move upwards and the break even point will be at a higher level of output than previously. Images © thinkstockphotos. co. uk

What If. . . Variable costs per unit rise? What will happen the fixed costs line? Answer: it will stay the same Which line will be affected? Answer: the total cost line. The new total cost line will begin at the same level as the fixed cost line but it rises more steeply than before. Images © thinkstockphotos. co. uk

What If. . . What if selling price per unit changes? What 2 lines will not be affected if the selling price changes? Answer: fixed cost and total cost lines So which line is left? Answer: total revenue line If the Selling Price of the product rises then the total revenue line will still come from 0 but it will be steeper. The Break-Even Point will be lower. Why is this? Images © thinkstockphotos. co. uk

Uses of Break-even Analysis • The main use of break-even analysis is to help in making decision about the level of output to produce and sell in order to produce a particular level of profit. • It can also help the entrepreneur decide whether or not the business will be viable: • If the break-even chart shows that the break-even point is above the output which market research suggests is demanded, then the business should not be run. • It is also very useful for ‘what if’ analysis: • This means that it can be used to work out what would happen to profitability and break-even output if one of the costs changed or if selling price was altered. Images © thinkstockphotos. co. uk

Limitations • Break-even analysis does not indicate what sales are actually likely to be for the product. This is an important limitation as it does not take into consideration what the demand for the product might be. • It assumes that fixed costs are constant. This may not always be the case as some economies of scale may arise. • It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. Again these may change as output levels change. • It assumes that the quantity of goods produced is equal to the quantity of goods sold. • It is sometimes difficult to classify costs as either fixed or variable. Some costs are semi-variable. Images © thinkstockphotos. co. uk

Pupil Activity Working individually you have thirty minutes to answer the following past paper questions: • 2011 Question 3 c • 2012 Question 3 a – d • 2014 Question 3 d – h Images © thinkstockphotos. co. uk

Learning Check Can you: • calculate break-even both graphically and by formulae • explain the significance of the break-even point • distinguish between fixed and variable costs • label a break-even chart • analyse a break-even chart • calculate the margin of safety and explain its significance for a business Images © thinkstockphotos. co. uk