Reference no: EM132249995
BREAK-EVEN ANALYSIS
The BREAK-EVEN ANALYSIS is the pricing technique used to determine the number of products that must be sold at a specified price to generate enough revenue to cover total costs and then to become profitable
Simply put, the break-even point is the point at which total revenue equals total costs. Revenue is the money flowing into the business as a result of the sales of the product, and costs are the expenses involved in producing the product.
In its most basic form, therefore, the formula for Break-Even Analysis is
REVENUE = EXPENSES
Revenue is dependent upon the selling price of the product. A business will sell more products at a lower price, but will need more sales at the lower price in order to cover the costs.
REVENUE = SELLING PRICE (QUANTITY SOLD)
Costs can be divided into two groups of costs:
fixed costs – those costs that remain stable at any production level,
such as a lease payment or insurance costs
variable costs – those costs that change with the level of production,
such as the raw material costs or direct labor costs
EXPENSES = FIXED COSTS + VARIABLE COSTS (QUANTITY PRODUCED)
The expanded formula for Break Even Analysis becomes
SELLING PRICE (QUANTITY SOLD) = FIXED COSTS + VARIABLE COSTS (QUANTITY PRODUCED)
Using the expanded formula for BREAK EVEN ANALYSIS, set up and work the following problems.
1. A firm has fixed expenses totaling $40,000, and production costs for each unit totaling $17.00. Testing a selling price of $25.00, how many units must be sold in order to break-even?
2. With a selling price of $40.00, how many units must be sold in order to break-even if production costs for widgets are constant at $36.00 per unit and fixed costs total $110,000?
3. A company breaks even when it sells 5,000 units. It costs the business 25.00 to produce each unit. The business’s fixed costs total $100,000. What must the selling price be?
4. When evaluating a break-even analysis, what would be the disadvantages that you see in to the process?