Break Even Analysis

The American University in Dubai

Research Report
Break Even Analysis

Jasmeen Kaur

A Paper
submitted to Dr.T.Jordan
of the Faculty of Business Administration,
The American University in Dubai

in partial fulfilment of
the requirements for the successful completion of
Marketing Management (MKT345)

Dubai, U.A.E
November 5, 2000


“Break-even point.” That’s the magic number that tells you when your revenue will cover your expenses, which is being used by experts for over 25 years. Although entrepreneurs often fail to realize the significance of recognizing and reaching the break-even point in the financial cycle, understanding what it takes to break even is critical to making any business profitable (Thompson, 1 and 4).

Break even directly relates to marketing because marketing managers are accountable for the impact of their actions on profits. Therefore, a working knowledge of basic accounting and finance is important to make decisions among various alternatives (Kerin and Peterson, 33). Several decisions are aided by this technique of analysis, such as those related to pricing and machinery or equipment purchasing, etc. because costs are incurred by all the activities that a business undertakes (Amos, 1)

Therefore, in business planning one might ask questions, such as, ‘How much do I have to sell to reach my profit goal?’, ‘How will a change in my costs affect my income?’ or ‘What prices should I charge to allow for a planned amount of profit?’. Hence, all these questions can be answered by the simple use of contribution analysis. As defined by Kerin and Peterson, contribution analysis is defined as ‘the difference between total sales revenue and total variable costs, or, on a per-unit basis, the difference between unit selling price and unit variable cost.

The simplest and easiest application of contribution analysis is the break-even analysis that helps access relationships among costs, prices, and volumes of products and services (Kerin and Peterson, 37). The fundamental definition of Break-even Analysis suggests that it is ‘a method of determining the relationship between total costs and total revenues at various levels of production or sales activity’ (Dubrin, 154).

Some Basic Concepts:

The principle idea behind break-even analysis is that all costs are variable, fixed or a combination of both. Break-even point at which the firm makes no profit or sustains no loss can be computed or it can be determined from a graphical representation of the relationship between revenue, cost and volume of productive capacity (Amos, 1).

1. Fixed Costs: Fixed costs are those costs that over a given period of time, are unaffected by changes in output (Hammond, 365). For example, a factory capable of producing 100 thousand engineering parts in a certain period of time might have fixed costs in terms of rent, heating, lighting and cost of machinery of $100 thousand for that period. Furthermore, even if the factory produces 80 thousand parts, it would still have to meet the same costs – the fixed costs.

2. Variable Costs: An increase in output will tend to lead to an increase in the amount of raw materials being used, an increase in power consumed and an increase in certain types of labor. These costs are known as variable costs because they vary with output (Hammond, 365). The simplest example of variable cost assumes that the cost of raw materials, labor and power will be the same for each unit produced, regardless of the level of output.

3. Total Variable Costs: Total variable costs (TVC) are defined by ‘output in a given period of time multiplied by the costs of labor and materials directly concerned with that output (Hammond, 365).

4. Total Costs: This figure is calculated by adding the total fixed costs (TFC) and the total variable costs (TVC) (Hammond, 365).

5. Revenue: The money received by a business from the sale of goods and services produced is termed as ‘revenue’. It is calculated by multiplying the selling price of each unit by the level of output (Hammond, 365).
The basic formula for the calculation of the break-even point is as follows:
Break-Even Point = Total Fixed Cost
Price – Average Variable Cost

Graphical Representation:
A break–even analysis graph represents the profit, loss, the various costs, the revenue, and the point where the firm covers all expenses, but not necessarily makes profits (Dubrin, 155).

Case Study

On a recent vacation trip to Juarez, Mexico, Mr. XYZ noticed small stores and street vendors selling original art. The prices ranged from $2 to $20