[Music] What is break-even analysis?
What is the implications on business decisions?
Welcome to practical business analysis my name is Americo Cunha, learn fast
solve problems, make good decisions, let's start the three most important applications of
break-even analysis on business decisions are One, determine the quantity of sold units
the quantity of sold units at which the cost equal the revenue
Two, find the quantity demanded at which the buying costs equal the internal production costs
3 compare business processes in determine the lowest cost
for requested quantity range let's get started on the first application
During business plan it is important to find out the sales quantity that cover the costs
any company has fixed costs and variable costs fixed costs are constant
whatever quantity of goods or services produced for instance salary must be
paid independently of units produced and therefore are considerate fixed costs
other fixed costs are property taxes leasing payments and depreciation
variable cost include direct costs to produce each unit, each item
the most common variable costs are raw material and components variable costs increase
with the quantity produced visually we can draw a graph that relates cost and quantity
you can see that the fixed costs are constant regardless of the quantity produced
on the other hand, variable cost increase with the quantity produced
the red line represents the total cost that is the fixed cost plus
the direct variable cost per unit produced the cost profile has to be compared to revenues
in this graph you can see the revenue the revenue is represented by the blue line
the revenue increase with the units sold
we can have a good visualization of the breakeven analysis where cost and revenue lines
are represented in the same graph when the total cost is higher than the revenue
the red line is above the blue line it means that the company is losing money
on the other hand when the blue line revenue is above the red line total cost
the company has profit the quantity at the intersection between the two lines is
called break-even quantity below this quantity
the company is losing money and above it, the company is making a profit
the break-even quantity is determined by dividing the fixed costs by the
difference between unit sale price - unit variable costs a second very common application
of the break-even analysis is to support the buy or make decision
the decision of buying supply items externally or produce them internally
there are several business factors that should be taking into account such as
strategic vision, time to market, tools available, knowledge, skills
in the last but not least cost analysis in which break-even analysis can be used
in the graph we have the buy alternative represented in green and
the make alternative in purple the fixed cost for the buy alternative is
almost zero therefore the total cost depends on the quantity purchased times the unit price
the make alternative is different it has a fixed cost to deployed infrastructure
to produce the products or to provide a service
it is important to realize that here we are looking for an alternative with the lowest cost
we can see that below the break-even quantity QB the green line buy alternative
has a lower cost above QB, the Purple Line make alternative
has the lower cost, the break-even quantity can be determined by dividing the fixed cost
by the difference between buying unit cost - making unit cost
the math is the same of the first example although the conclusion is different
the third application of the break-even analysis is to select a process alternative based on
the quantity demanded, to facilitate the understanding let's suppose three
types of production process the first a manual process
the second semi-automated process and the third I entirely automated production process
the manual process has the lowest fixed cost and highest variable unit cost
on the other extreme, we have the fully automated solution that has the highest cost to be deployed
but can deliver the lowest unit production cost we can compare the three
alternatives visually by plotting each total cost per quantity produced
we can see that each alternative has the lowest cost depending on the quantity produced
lower quantities make the manual production process very attractive cost wise
what can be seen in the blue area of the graph
below the break even quantity QB1 the manual process has the lowest total cost
the sami-automated alternative is very competitive when the demand is
between quantities QB 1 and QB 2 above the break-even quantity QB2
the fully automated alternative has the best cost performance
the math is the same used before but now should be done considering two alternatives each time
[Music] to conclude, in this video we saw three applications
of the break-even analysis one, cost versus revenue
two, buy or make decision and three, process selection
now I think you can answer three questions what is break-even analysis
what are the three most common applications how to apply break-even analysis to support business decisions
you can send your questions in the comment area below
I'll be very pleased to answer them thanks for watching and don't forget to subscribe
see you in the next lesson [Music]