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Break-even Analysis

break even, production, price, marketing, price, price management, marketing management

Break-even chart

First plot the fixed costs and total (fixed plus variable) costs and the number of units being sold. Then plot the revenue against the number of units sold (revenue = number of units times price per unit). Where total revenue equals total cost we have the break-even point, but only at that price.

We can go on to plot a series of break-even charts at different prices, to establish how many units we would need to sell in order to break even at each price in turn. At the same time we can do a similar series of calculations (or they might have to be 'intelligent guesses') to find what the level of demand is likely to be at each price. We can then say, 'At price level X, demand is likely to be Y units and at Y units we do or do not break even'.

Thus if a firm has fixed costs of $10,000, a selling price of $6 per unit and variable costs of $4 per unit, the break-even quantity (the quantity that must be sold before any profit is achieved) is 5,000 units. The figure arrived at when variable cost per unit is deducted from selling price is known as the contribution.

We see, then, that the cost per unit changes as the number of units changes. Generally speaking, the cost per unit decreases as the total number of units increases. However, it is possible to reach a situation, where overtime rates or shift-work, coupled with fully utilized equipment lead to a sharp increase in cost per unit.

Thus to fix a price based on cost plus profit, we have to decide first at what level of production cost is to be calculated. If in fact that level is not reached, profit may be much less than anticipated or there could even be a loss. Even greatly exceeding the anticipated level of production may bring higher costs in some cases — with the same result.

In any case our price must be related to what customers expect to pay. Cost represents the level below which the price cannot go. In situations where manufacture is on a contract basis — in civil engineering for example — the level of output is exactly known in advance. The desired margin of profit can be added to produce a price that is then either above or below the competition's, and acceptable to the customer or not acceptable. But in the majority of situations, where cost per unit depends on the (as yet unknown) quantity to be produced, other factors have to be taken into account.
Published: 2007-04-30
Author: Martin Hahn

About the author or the publisher
Martin Hahn PhD has received his education and degrees in Europe in organizational/industrial sociology. He grew up in South-East Asia and moved to Europe to get his tertiary education and gain experience in the fields of scientific research, radio journalism, and management consulting.

After living in Europe for 12 years, he moved to South-East again and has worked for the last 12 years as a management consultant, university lecturer, corporate trainer, and international school administrator

www.martin-hahn.net

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