Break even Analysis

Topics: Costs, Variable cost, Cost Pages: 5 (1590 words) Published: November 20, 2013
Break even analysis is an important part in production management and decision making. In this assignment, the key elements of the break-even analysis will be discussed. The key elements of break-even analysis are fixed cost, variable cost, total revenue, break-even point and margin of safety. Although break-even analysis is very useful, it has disadvantages. Break-even analysis is based on the production cost of the company which includes the fixed cost and variable cost. Then the total cost of the production is compared with the total sales revenue to find out the breakeven point. The break even analysis is useful to determine how much sales does the company need to make in order to break even. (Holland, 1998) It is broadly used in management and forecasting in sales. A manager might use break-even analysis to determine the break-even point to make decision on setting the price of the product. The break-even analysis also provides information on the profitable of the products. The company will decide whether they still need to sell products that generate low profit. Fixed cost is cost that will remain the same no matter the change in level of output. Generally, fixed costs are fixed over the level of output. Examples of fixed costs are rent, depreciation, and administration cost. But there are situation where fixed cost will change. For example, the rent of a tuition centre is £500 at the beginning of the business. After a few months, the number of students of the tuition centre had increase in which they need to rent more rooms for their business. This caused the rent to increase to £700. From this situation, we know that fixed cost is a period cost. It will remain the same for a short term but not for the long run of the business. (Walker, 1997: 116)

Variable cost is cost that will change with the change of output. The variable cost varies directly to the level of output. The higher the level of output, the higher the variable cost and vice versa. Examples of variable costs are raw material and wages. There are two types of variable cost which is the direct variable costs and indirect variables cost. Direct variable costs are costs that are directly incurred in the production of the product. Examples include raw material and wages which are involve in production line. Indirect variable costs are cost that does not involve directly in production but they do vary according to output. Examples include factory manager’s salary, maintenance, certain labour cost. (tutor2u, 2010)

There are also some costs which have both the fixed and variable cost. These costs are called semi-variable costs. The semi-variable cost is incurred even though the level of output is zero. For example, the factory needs to pay line rental for the telephone bill which is fixed; yet the factory needs to pay further telephone charge depends on the level of output. This means that certain parts of the telephone bill are fixed and some are variable. (tutor2u, 2010)

The total revenue is the total amount of money received from the sales of the business of any quantity of output. Total revenue is also known as turnover. Total revenue = Quantity × Selling price. (BBC, 2010)For example, a toys company sold 1000 teddy bears in a year. The selling price of one teddy bear is £10. So the total revenue of the company is £10000 (Sales quantity × selling price = 1000 × £10 = £10000). Contribution is the amount of money contributes to the fixed cost and if access contributes to profit. It is the money remained after deducting the variable cost from the selling price (Hall, 2008: 194). Contribution = selling price – variable cost. For example, the selling price for a can of beer is £3 and the variable cost is £0.90 per can. The contribution of a can of beer is £2.10 (Contribution = selling price –variable cost = £3- £0.90 = £2.10). The break even chart is a useful management tool which represents the graph of sales against level of...
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