Break Even Analysis

A variety of definitions are ascribed to the term break-even analysis.  The most important description thereof is as follows:

It is the point at which the costs are equal to the income, i.e. where no profit or loss is made.

The small manufacturer must, therefore, determine the sales level where the total income is equal to the total expenses.

To have a clear understanding of break-even analysis, one first has to distinguish between fixed and variable costs.  It is not always easy to distinguish which costs are fixed and which are variable, because they differ from business to business.

Fixed Costs

Fixed costs are those costs that remain fixed regardless of the volume produced.  For example, the rent of a factory is R 4 000 per month.  It does not matter whether 10 000 units were produced; the rent of
R 4 000 per month must still be paid.  The following costs are examples of fixed costs:

  • Lease of machinery and equipment, lease of office furniture
  • Depreciation
  • Salaries and wages
  • Advertising
  • Admin costs, sales expenses etc.

Variable Costs

The variable costs have a direct relationship with the volume produced.  Where R100 of raw material is to be used for manufacturing bricks, it would mean that a R100 raw material would be required for every additional table.  Additionally, more glue, screws, sandpaper, etc, would be required for every additional table.  Examples of some variable cost items are:

  • Direct and indirect material
  • Direct and indirect labour
  • Sales commission
  • Packing materials etc.
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