3.3 Costs and break-even analysis

3.3.1 The concept and calculation of:

  • Revenue

  • Fixed costs

  • Variable costs

  • Total costs

  • Profit and loss

Revenue - The income a business earns from selling goods or services.

Formula: Revenue = Price per unit × Quantity sold

Fixed costs - Costs that do not change with the amount of production or sales.

Variable costs - Costs that vary directly with the amount of production or output.

Formula: Variable Costs = Cost per unit × Number of units produced

Total costs - The sum of fixed costs and variable costs.

Formula: Total Costs = Fixed Costs + Variable Costs

Profit and loss - Profit is the financial gain when revenue exceeds total costs, and loss occurs when total costs exceed revenue.

Formula: Revenue - Total Costs

3.3.2 The concept of break-even and calculation of break-even (from formula or diagram)

Break-even - The point where a business’s total revenue equals its total costs, meaning it makes neither a profit nor a loss.

Break-even level of output - The quantity of goods a business needs to sell in order to cover its total costs.

Formula: Break-Even point = Fixed Costs ÷ (Sales price per unit – Variable costs per unit)

3.3.3 Interpretation of break-even charts

The impact of changes in revenue and costs on the break-even point

  • An increase in revenue would lower the break-even point as fewer units must be sold to cover total costs.

  • A decrease in revenue would increase the break-even point as more units must be sold to cover total costs.

  • Increased costs would cause an upward shift in the break-even point as more units must be sold to cover total costs.

  • Decreased costs would cause a downward shift in the break-even point as less must be sold to cover total costs.

Limitations of break-even charts

  • Costs do not always increase in direct proportion to units sold - Businesses may negotiate bulk-buying discounts that lower average variable costs or fixed costs could increase, as additional workers or equipment may be needed, during times of producing more output. 

  • Revenue does not always increase in direct proportion to units sold - Buyers of large orders may could request and receive discounts, therefore the selling price per unit would decrease.

  • Cost data is often an estimate - Data regarding costs may not be accurate enough to produce reliable data on breaking-even.

  • Some output may remain unsold - The chart assumes all units are sold, however, additional unsold stock may be sold at a lower price.