Hi, my name is Grant Hobson. I have been a finance analyst for the last six years. Today I am going to run you through some financial performance methods as well as some investment appraisal techniques.
To calculate break even, Break even analysis is a technique which is widely used by production management and management accountants. It is based on categorizing your production cost between those which are fixed and those which are variable. If you are not familiar with how to get to your variable cost and your fixed cost, then it will be beneficial to look this up and just familiarize yourself with the calculation.
The way break even works is that you total variable and fixed cost and compare it with the sales revenue in order to determine the level of sales volume, sales value or production at which the business will make neither a profit or a loss. Calculation works as follows: so if we look at this product which sells at four pound a unit, it has a variable cost of one pound and twenty a unit and then we have fixed cost of two thousand pounds. To find the break even point, you take your fixed cost and you divide this by the selling price less your variable cost per unit.
So, in this example, it will be a two thousand pound divided by the four pound less your one pound twenty which gives you seven hundred and fourteen point
three. Now obviously, we don't produce seven hundred and fourteen point three units, you round this up and your break even point is seven hundred and fifteen units to break even. When calculating break even, it is common to view a break even chart which just demonstrates the relationship of the cost to the output in units that you produce.
You can see on the chart we have a fixed cost line which is obviously fixed and the level across as the output increases and then we have total cost line which increases as output increases and this is because each unit has a variable cost of production which is added on top at the fixed cost line. Now when the total cost line and the revenue cost line cross at this point, here you see the break even point and that is the point of seven hundred and fifteen units that we just referred to a second ago. The total cost line in purple and the profit line and revenue line in green, this section here, once you break even is where you start making your profits so we can see the more you produce, the more profit we will make because the fixed cost is a flat so all we have then is the variable cost per unit.
Company sell reduces when we produce more units because we are getting cheaper raw materials or cheaper cost of production because of the volume we are doing.