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Break even analysis

A typical entrepreneur is unprepared to evaluate a pricing system until he or she


understands potential costs, revenues, and product demands for the venture. To better
comprehend these factors and to determine the acceptability of various prices, the entrepreneur
can use break even analysis. An understanding of markup pricing is also valuable, as it
provides the entrepreneur with an awareness of the pricing practices of intermidiaries-
wholesalers and retailers.
Break even analysis requires an estimation of fixed costs, variables cost and revenues.
Break even analysis- a means of finding the point, in dollars and units, at which costs
equal revenues.
Fixed costs- costs that continue even if no units are produced
Variable costs- Costs that vary with the volume of units produced
Contribution ( marginal revenues)- the difference between selling price and variables
costs.
Two approaches to make break even analysis: graphic and algebraic.
Algebraic approach. The respective formulas for the break even points in units and dollars are
shown below. Let:
BEPx= breal even point in units
BEP$= break even point in dollars
P = price per unit (after all discounts), or total price
X = number of units produced
TR= total revenue=Px
F = fixed costs
V = variable costs per unit
TC = total costs= F+Vx
(P-V)= contribution, marginal profit
Break even point occurs where total revenues equals total cost. Therefore:

BEPx = F/(P-V) or Total fixed cost/marginal revenues

and BEP$= F/(1-V/P) or BEP$=BEPx*P

Example single product case.

Master of sports of international class in artistic hymnism Elena, forced to leave the big
sport, decided to open a dance school with a gym, sauna and aerobics room.
The initial costs are:
*Renovation and reconstruction of the premises - 1500 thousand. Lei
*Trainers-500 thousand lei
*The equipment for a sauna is 250 thousand liters.
The costs for the restructuring of premises and equipment will be amortized over a six-
year period on the basis of uniform depreciation and the assumption that at the end of this
period the cost of these non-current assets will be 0.
Periodic annual costs will be:
*Repair and maintenance of premises - 150 thousand lei
*Maintenance of equipment - 200 thousand lei
*The cost of staff salaries will vary depending on the demand for the services of the school-
studio. It is expected that they will average 5,000 lei per student per year, and the annual fee
for school is 7500 lei.
1. Elena would like to know how much students she should accept every year, so that her
business starts to make a profit.
2. Calculate the profit or loss for the school-studio of Elena, if the annual number of students
is -500, 250, 400 students.
3. Elena conducted a marketing research and learned that it is possible to increase the number
of students from the current level of 400 people to 750, if you reduce the fee from 7500 to 6000
lei. What is the new break-even point? Show it on the chart. Is it advisable to do this in terms
of profit?
4. Elena's studio has been working for a year and the number of students has reached 400
people. Meanwhile, the idea of such a school became popular, and a month ago in the same
district of the city Andrew opened a similar school. The costs of Elena studio are characterized
by relatively low fixed costs and its policy is to attract people to aerobics classes at the expense
of high-quality personal service with the help of attentive qualified personnel.
Andrew has another strategy. In his gym there are many modern simulators with
electronic sensors. Thus, the attention of the staff to clients is required significantly less.
Although the initial costs for equipment-7500 thousand lei were high. The cost of maintenance
and repair of premises and equipment is 400 thousand lei a year. Variable costs are at a lower
level than for Elena-2800 lei per customer. The fee for classes is -7500 lei per person. Using
the methods of breakeven analysis, calculate the break-even point for the Andrew. Compare
the strategies of Elena and Andrew in terms of sustainability and profitability of the business

Example of Multiproduct case


Most firms, from manufactures to restaurants, have a variety of offerings. Each offering may
have a different selling price and variable cost. Utilizing break even analysis, we modify our
formula to reflect the proportion of sales for each product. We do this by “ weighting” each
product’s contribution by its proportion of sale. The formula is then:

BEP$= F/ Sum[(1- Vi/Pi)*(Wi)], where

V= variable cost per unit


P=price per unit
F=fixed cost
W=percent each product is of total dollars sales
I=each product

Problem:
Le bistro makes more than one product and would like to know its break-even point in dollars.
Information for the bistro follows. Fixed costs are= 3500$ per month. Number of working
days= 312 days. Also Le bistro want to know the break even for the number of sandwiches that
must be sold every day.

Item Selling Variable Annual


price cost forecasted
(P)/$ (V)/$ sales /units
Sandwich 2,95 1,25 7000
Soft drink 0,8 0,3 7000
Baked potato 1,55 0,47 5000
tea 0,75 0,25 5000
Salad bar 2,85 1,0 3000
total