The Breakeven Chart
LMC explains The Breakeven Chart
A breakeven chart is a strategic tool used to plot the financial revenue of a business unit against time or sales to determine the point when sales output is equal to revenue generated. This is recognised as the breakeven point. The information used to determine and analyse the breakeven point includes fixed, variable and total costs and the associated sales revenues. They are defined as:
- Fixed costs: costs that do not vary in relation to the level of sales output, for example rent.
- Variable costs: costs that vary in proportion to the level of sales output, for example materials.
- Total costs: the sum of all costs, including fixed and variable.
- Associated sales revenues: the total revenue made by the company from sales. It can be derived by multiplying price by output.
The analysis of a breakeven chart considers whether a venture runs at a profit or a loss. Sales above the breakeven point indicates continued and profitable growth. The principle of break-even theory is that during the early stages of a business venture, total costs, both fixed and variable, exceed sales. As output increases, sales begin to rise faster than costs and, eventually, they become equal (breakeven point). If sales continue to rise and exceed total costs, the business achieves profitability.
The tool assumes that all the goods which are produced will be sold and that costs, namely the price, will remain constant. Likewise, it also relies on the capacity in terms of output to remain unchanged.
Breakeven charts are universally applied to simply and graphically illustrate and forecast a company's projected revenue, and to calculate the time for profitability to be reached. It is used by financial and marketing strategists to predict the effect that changes in price will have on the percentage change in sales over time. It is also a useful tool to analyse the relationship between fixed and variable costs and to predict the effect on profitability of changes to those costs.
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