Break-even — Edexcel A-Level Business
Test yourself on Break-even with PEARSON EDEXCEL A-Level practice questions.
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Break-even explained
Contribution per unit is what one extra sale leaves behind once the costs that only exist because that unit was made have been paid, so it funds fixed costs first and turns into profit only after those are covered.
Read the full explanation
Total contribution is contribution per unit multiplied by units sold, measured in pounds. A coffee shop charging £3.20 for a latte whose milk, beans and cup cost £0.95 keeps £2.25 a cup, so 4,000 cups a month put £9,000 towards rent and salaries. The figure decides special orders, which line to push and whether a loss making product is worth keeping, because a product with positive contribution still pays for overheads that would remain if it closed. The trade off is the assumption that variable cost per unit never moves, which bulk discounts and overtime premiums break.
b) Break-even point: total fixed costs + total variable costs = total revenue
This is the output at which the money coming in exactly matches the money going out, so the firm makes neither profit nor loss and every sale beyond that level adds its contribution straight to profit. It is measured in units of output and can be restated in sales revenue by multiplying by price. A gym with yearly fixed costs of £120,000, membership at £40 a month and a variable cost of £10 a member covers itself at 4,000 member months, roughly 334 members held all year. Lenders and investors ask for the figure because it shows the minimum trading level a repayment schedule depends on, and managers use it to set the target a launch has to beat before it earns anything.
c) Using contribution to calculate the break-even point
Dividing total fixed costs by contribution per unit tells a firm how many sales it needs before the overheads are paid, and it is far faster than plotting lines on a chart because it works in money per unit. The same arithmetic answers the more useful question of what output a target profit needs, by adding that profit to fixed costs before dividing. A printing firm with fixed costs of £48,000 that keeps £6 a job after ink and paper covers itself on 8,000 jobs and needs 10,000 jobs to make £12,000. The method is sensitive, and that is the point worth making in evaluation: a small price cut shrinks contribution and moves the required output sharply, which is why discounting is more expensive than it looks.
d) Margin of safety
The gap between the sales a firm expects and the sales it must make to cover its costs is its cushion against a downturn, found by taking break even output away from budgeted or current output and often restated as a percentage of that output. A bakery selling 6,000 loaves a week that covers its costs at 4,500 has a cushion of 1,500 loaves, a quarter of sales, so demand can fall by a quarter before losses begin. A thin figure argues for cutting fixed costs, raising price or adding a second revenue stream, while a generous one supports investment or a promotional price cut. Seasonal firms should judge it in the worst trading month rather than on a yearly average that hides exactly the risk it is meant to expose.
e) Interpretation of break-even charts
These charts put output along the horizontal axis and money up the vertical one, with a flat fixed cost line, a total cost line that starts level with fixed costs and rises by the variable cost of each unit, and a revenue line drawn from the origin. Where revenue crosses total cost the firm covers its costs; the vertical gap between the two lines to the right of that crossing is profit and the gap to the left is loss, while the horizontal distance from the crossing to expected output is the margin of safety. Most marks come from reading change rather than reading the picture: a price rise steepens the revenue line and pulls the crossing left, extra rent lifts the whole cost line and pushes it right.
f) Limitations of break-even analysis
The technique is a planning aid resting on assumptions a real market breaks: it prices every unit the same when firms discount for volume, it draws variable cost per unit as constant when bulk buying and overtime bend it, it assumes everything made is sold so stock never builds, and it says nothing at all about whether demand exists at that price. It handles one product at a time, which is awkward for a firm spreading overheads across a range, and it is static, so the figures date the moment a supplier raises a price. None of that makes it useless. It is cheap, quick and persuasive to a lender, and it is at its best when the price and cost figures are tested at optimistic and pessimistic values rather than treated as a forecast.
Your focus
- a) Contribution: selling price – variable cost per unit
- b) Break-even point: total fixed costs + total variable costs = total revenue
- c) Using contribution to calculate the break-even point
Show all 6 objectives
- d) Margin of safety
- e) Interpretation of break-even charts
- f) Limitations of break-even analysis
Break-even exam tips
Marking Points
- Contribution per unit worked as selling price minus variable cost per unit, and total contribution as that figure multiplied by units sold, with money units on the answer.
- Case figures used rather than invented ones, so the calculation belongs to the named business and its own cost data.
- The figure carried into a decision, such as accepting a special order, dropping a line or changing price, with the effect on fixed cost cover stated.
- Clear recognition that contribution is not profit until total fixed costs have been covered.
- A statement that at this point sales revenue equals total costs, with fixed and variable costs both counted and profit therefore nil.
- Fixed costs divided by contribution per unit, with the answer rounded up to a whole unit because part of a sale does not exist.
- Units named on the answer, and break even revenue found by multiplying break even output by selling price where the question asks for money.
- The answer compared with current or forecast demand from the extract, with a comment on how much cover the firm has.
- Fixed costs divided by contribution per unit, both figures lifted from the case, with the answer given in whole units.
- Target profit output shown as fixed costs plus the required profit, the whole amount then divided by contribution per unit.
- Working set out line by line so a method mark survives an arithmetic slip, with money units carried through.
- A comment on sensitivity, saying what a price change or a rise in variable costs does to the required output.
- Calculated as budgeted or actual output minus break even output, stated in units of output.
- The percentage form given where asked, that difference divided by budgeted output and multiplied by one hundred.
- Interpreted as how far sales can fall before a loss, and tied to the demand risk described in the case rather than left as a number.
- A judgement on what a small cushion means for the firm, such as reducing fixed costs or raising contribution.
- Axes read correctly, output in units across and revenue and costs in pounds up, with the crossing of the revenue and total cost lines identified.
- Profit or loss at a stated output read as the vertical distance between the revenue and total cost lines, and named as profit only beyond the crossing.
- Margin of safety picked out as the horizontal distance between the crossing and current or budgeted output.
- The effect of a change described by naming which line moves, whether it shifts or tilts, and which way the crossing travels.
- Named assumptions challenged rather than listed: one price for all units, straight line variable costs, all output sold, a single product, unchanging data.
- The consequence spelled out, for example that a volume discount makes the revenue line an overstatement and the true break even output higher.
- Balance shown, with the low cost and planning value of the technique weighed against its weakness as a forecast.
- A judgement that depends on context, such as how volatile costs and demand are in that industry.
Examiner Tips
- 💡Short calculation questions carry a method mark, so write the subtraction out before the answer and keep the pound sign on it.
- 💡In longer answers the contribution figure is evidence rather than the answer; the marks come from what it tells the firm about pricing, capacity or which order to accept.
- 💡Data usually arrives as annual totals in a table, so convert fixed costs and variable costs into matching per unit and per period terms before dividing.
- 💡The calculation is rarely the whole question; expect a follow on asking whether that sales level is realistic given the market information in the extract.
- 💡Where the extract gives monthly fixed costs and yearly demand, put both on the same time period before dividing and say which period your answer covers.
- 💡Write the formula down first in a short calculation; in longer answers use the figure as evidence inside a judgement about the decision.
- 💡This is usually the second half of a break even calculation, so keep the break even figure on the page and reuse it rather than starting again.
- 💡In assess and evaluate questions it is the risk measure, so link its size to how volatile demand looks in the extract before you judge a plan.
- 💡The chart is normally supplied, so practise pulling three things off it quickly: break even output, profit at current output and the margin of safety.
- 💡When the extract announces a price or cost change, say which line moves and roughly by how much before judging whether the plan is safe.
- 💡These points are the evaluation half of a break even question, so save one for the conclusion instead of spending them all in the opening paragraph.
- 💡Anchor every criticism in a figure from the extract, such as the discount offered to a large customer that a single price assumption hides.
Common Mistakes
- Subtracting total cost per unit, including a share of overheads, which gives profit per unit and corrupts every break even figure built on it.
- Closing a line that still makes a positive contribution, forgetting that the fixed costs stay behind and profit falls further.
- Muddling per unit and total figures, for example dividing total variable costs by the wrong level of output.
- Dividing fixed costs by selling price instead of by contribution, which ignores the variable cost of each unit and understates the output needed.
- Rounding down, so the stated output actually makes a small loss.
- Adding the full selling price of later units to profit rather than their contribution.
- Using total contribution rather than contribution per unit, which produces a meaningless fraction.
- Leaving out a fixed cost buried in the extract, such as rent paid quarterly or a manager salary payment, so the required output is understated.
- Adding the target profit to contribution instead of to fixed costs.
- Subtracting the wrong way round and reporting a negative figure as a cushion, when it actually means the firm is trading below break even.
- Taking the percentage against break even output instead of against budgeted output.
- Treating the figure as money; it is a quantity of sales, and only contribution turns it into profit.
- Drawing or reading the total cost line from the origin, which loses the fixed costs and places the crossing far too low.
- Reading the crossing off the vertical money axis when the question asks for output in units.
- Shifting the total cost line upwards for a change in variable cost, when what actually changes is its gradient.
- Listing weaknesses with no link to the business in the case, which caps the answer at knowledge marks.
- Claiming the technique ignores fixed costs, when it is built on them; what it ignores is demand and the reliability of the cost data.
- Concluding that a firm should abandon the technique without asking what a small business could realistically use instead.