What are fixed and variable costs?
Fixed costs are the costs you will bear no matter how well or badly the business is doing. For example:

• Rent/Rates
• Stationery
• Telephone
• Motor Expenses

Variable costs are costs which depend on the level of sales in the business. For example

• Raw Materials
• Direct Labour
• Bought in Parts
• Bought in Product

Break Even is the level of sales your business needs to achieve before your business covers all its costs, including your essential drawings, but before it makes a profit.

Contribution With variable costing a clear distinction is made between fixed and variable costs as defined above. Conventionally total variable costs are computed for each unit of output and contribution is defined as the difference between the selling price and the variable cost.

Why bother looking at the break even point?
Unless you can identify what the break-even point for your business is you could easily operate at a loss without realising until it is too late.

Knowing the break-even point allows you to reconsider the financial assumptions previously incorporated into the Business Plan and allows you to review a number of different aspects of the proposal namely:

1. Does the market research and customer analysis support projected sales forecast?
2. If reducing costs means lowering quality, will this be acceptable to customers?
3. Can fixed costs be reduced without harming the business?
4. Have projected sales been over/underestimated?
5. Are pricing levels correct or should lower cost suppliers be found?

Activity 3
Below you can see graphically how break even point varies.