Understand the meaning of the term break-even output and interpret…

The idea

Break-even output is the quantity of units a business must sell for total revenue to equal total costs, making neither profit nor loss. On a break-even chart, the horizontal axis shows output and the vertical axis shows money. The total revenue line starts at the origin; the total cost line starts at fixed costs. The point where the lines cross is break-even output. Below it, total costs exceed total revenue, creating a loss; above it, total revenue exceeds total costs, creating a profit. The vertical gap between the lines at any output shows the amount of profit or loss. The horizontal gap between current output and break-even output is the margin of safety. Changes in price, variable cost or fixed cost shift the lines and change break-even output.

What earns the marks

• Defines break-even output as the level of sales where total revenue equals total costs, resulting in neither profit nor loss.
• Identifies the axes of a break-even chart: output or units on the horizontal axis and money on the vertical axis.
• Describes the total revenue line as starting at the origin and rising with output, and the total cost line as starting at fixed costs and rising with variable costs.
• Locates break-even output at the intersection of the total revenue and total cost lines.
• Interprets areas of the chart: below break-even output the business makes a loss; above it the business makes a profit.
• Explains how a change in price, variable cost or fixed cost shifts the lines and therefore changes break-even output.

Common mistakes and how to put them right

• Confusing break-even output with maximum profit.

  Put it right by stating that break-even is where total revenue equals total costs, not where profit is highest.

• Reading the vertical axis as output.

  Put it right by checking that output is on the horizontal axis and money is on the vertical axis.

• Assuming the total cost line starts at the origin.

  Put it right by noting that it starts at the fixed cost level because fixed costs are incurred even at zero output.

• Confusing the margin of safety with profit.

  Put it right by remembering that margin of safety is a horizontal measure of output, whereas profit is a vertical measure of money.

Exam tips

• Label both axes and the lines clearly when drawing or interpreting a chart, and mark the break-even point where the lines cross.
• Use the chart to explain what happens below and above break-even output, referring to profit and loss.
• When a change is described, state which line shifts and in which direction, then explain the effect on break-even output.