Break-even Charts (Edexcel IGCSE Business)

Elements of break-even charts

Spec point — 3.3.3 · Interpretation of break-even charts:

• A break-even chart is a visual representation of the break-even point in a graph

• Three lines are plotted on a graph with an x-axis labelled units and a y axis labelled costs/revenues

  • Fixed costs
  • Total costs
  • Revenue

• The break-even point is the output level at which the revenue and total costs line cross

• The break-even chart can also be used to identify the following

  • Profit or loss at different levels of output

    • Profit is achieved when revenue is greater than total costs
    • A loss occurs when total costs are greater than revenue

  • The margin of safety, which is the difference between the actual level of output and the break-even point

Interpreting break-even charts

Spec point — 3.3.3 · Interpretation of break-even charts:

• The elements can be identified in the break-even chart below

  • The selling price is £32 per unit
  • Variable costs are £7.60 per unit
  • Fixed costs are £8,000

Break-even chart with key elements

*The break-even chart shows the break-even point, profit at a given level of output and the margin of safety  *

• Fixed costs do not change as output increases

  • Fixed costs are £8,000 and these do not change whether the business produces 0 units or 500 units
  • It is therefore represented by a horizontal line at £8,000 for all levels of output

• Total costs are made up of fixed and variable costs

Fixed, variable and total costs at different levels of output

• At 0 units of output, total costs are made up exclusively of fixed costs
• At 500 units, the total costs are £11,800

$Total Variable Costs = Units \times Variable Cost per Unit$

$= 500 \times £ 7.60$

equals space £ 3 comma 800

Total space Costs space equals space Fixed space Costs space plus space Total space Variable space Costs

equals space £ 8 comma 000 space plus space £ 3 comma 800

equals space £ 11 comma 800

• In the chart, the total costs line slopes upwards because total variable costs increase as output increases
• Revenue is the quantity sold x selling price

Revenue at different levels of output

• The revenue line also slopes upwards

  • At 0 units of output, the revenue is £0
  • At 500 units the total revenue equates to £16,000
  • Revenue increases with output
  • The line will slope more steeply than the total costs and will cross the total costs line at some point

• The point at which the total costs and the revenue lines cross is the break-even point

  • The break-even level of output is 328 units

• The margin of safety can be identified as the difference on the x-axis between the actual level of output (in this case, 450 units) and the break-even point

  • The margin of safety is 450 - 328 = 122 units

• The profit made at a specific level of output can be identified as the space between the revenue and total costs lines

  • In this instance, the profit made at 450 units of output is £14,400 - £11,420 = £2,980

Exam Hint You will not be required to draw a break-even chart in the exam but you could be asked to manipulate a diagram that has been provided

You could be asked to

• Illustrate a change to the selling price, variable costs or fixed costs on the diagram
• Mark the break-even point or margin of safety
• Identify the amount of profit (or loss) made at a given level of output
• Label elements such as axis names or cost/revenue curves

The impact of changes in revenue and costs

Spec point — 3.3.3 · Interpretation of break-even charts: • the impact of changes in revenue and costs

The impact of changes in revenue and costs

• Changing in the selling price, variable cost per unit or total fixed costs affects the break-even point and level of profit or loss

How the break-even point and level of profit is affected by changes in variables

Limitations of break-even charts

Spec point — 3.3.3 · Interpretation of break-even charts: • limitations of break-even charts.

Limitations of break-even charts

• Whilst they provide an accessible way to understand costs, revenues and break-even there are some limitations of using break-even charts to support decision making

1. Costs do not always increase in direct proportion to units sold

• Businesses may be able to negotiate bulk-buying discounts that reduce variable costs per unit at high levels of output
• Fixed costs could increase significantly at higher levels of output as more staff or equipment may be required

2. Revenue does not always increase in direct proportion to units sold

• Buyers may demand discounts for placing large orders, which will reduce the selling price per unit

3. Cost data is often estimated

• If break-even charts are used for forecasting, future cost estimates are used
• The reliability of these estimates depends on the skills and experience of buyers and financial planners

4. Some output may remain unsold

• The model assumes that all units produced are sold
• In reality, businesses keep some stock as a buffer to meet demand at a later date
• Unsold stock may be sold at a lower price to reduce storage costs or raise cash