Business Opportunity

•

Lunchtime pitch for a sandwich stall

• Monday – Friday: 100 customers per day • Average spend per person = £5 • Cost of production is about half the selling price • Rent for the pitch = £1000 per week

Should I do it?

Break-even analysis

TY - 2009

Definition

•

Break Even

is the point at which sales revenue is equal to total costs. It is the point at which the business is making neither a profit nor a loss.

• So,

break-even analysis

tells a business how much it needs to sell to cover its costs TY - 2009

Businesses incur two types of costs

•

Fixed Costs

are •

Variable costs

are TY - 2009

Businesses incur two types of costs

•

Fixed Costs

are the costs that

do not change

in-line with the number of units produced/sold.

•

Variable costs

are TY - 2009

Businesses incur two types of costs

•

Fixed Costs

are the costs that

do not change

in-line with the number of units produced/sold.

•

Variable costs

are the cost that

do change

directly in-line with output.

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Break-even

(the point at which a business is making neither a profit nor a loss!)

This is the formula to work out exactly how many units we need to sell to break even Selling price Variable costs =

(per unit) (per unit)

“ Contribution ” Total fixed costs Contribution =

Break-even Point

(the number of units needed to break-even)

“ Contribution ”

is the amount of money each unit contributes towards the fixed costs of business TY - 2009

For Example:

• If a product sells for £15 and has variable costs per unit of £11 what is its contribution?

• If the business has fixed costs of £20,000,how many units would it need to sell to break-even?

Each unit sold will make a contribution of £4 towards fixed costs of business.

£20,000 ÷ £4 =

5,000 units

order to break-even must be sold in So, 5,000 units = the “break-even point” TY - 2009

Break Even Example

Hackett’s Hair Salon

• Kenny Hackett runs a small but very fashionable hairdressing salon. His business has annual fixed costs of £54,000. Kenny has calculated that the cost of providing a standard cut, colour and style is £40.00 and he currently charges £100 for this service.

TASK: Complete the table on the handout then a draw break even chart

TY - 2009

Break Even Chart

Sales Revenue The break even point TOTAL COSTS

TY - 2009

Fixed Costs Variable costs

Number of units

Hackett’s Hair Salon

Break Even Point

TY - 2009

Importance of Break-even analysis

• Contribution from every unit sold above the breakeven point adds to profits • Breakeven point can provide a target for a business to exceed • It helps to work out whether forecasted sales will produce a profit and whether further investment in product is worthwhile.

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Limitations of Break-even analysis

• Does not take into account possible changes in costs over time period • Does not allow for changes in selling price • Analysis is only as good as the quality of the information used • Does not allow for changes in market conditions – e.g. entry of new competitor

Structure for Break Even content of P6

• Define break even and explain how this tool can be useful when running a business.

• Explain how it can be a useful step in the budgeting process: –

Setting sales targets

–

Setting targets related to costs

–

Helping to decide if a proposed deal is good

• Demonstrate the calculation of the BEP for Eco Clothing Ltd. (show formula and working from class) • Include the BE table you produced (include the graph you produced as ‘Appendix A’)