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Cost Scale & Break-Even Analysis Guide

Chapter 16 discusses the cost scale of production and break-even analysis, emphasizing the importance of understanding fixed and variable costs in business decisions. It explains economies and diseconomies of scale, highlighting how larger businesses can benefit from reduced average costs but may face challenges in coordination and communication as they grow. The chapter also outlines break-even analysis as a crucial tool for determining the minimum sales needed to cover costs, while noting its limitations due to assumptions that may not hold true.

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7 views3 pages

Cost Scale & Break-Even Analysis Guide

Chapter 16 discusses the cost scale of production and break-even analysis, emphasizing the importance of understanding fixed and variable costs in business decisions. It explains economies and diseconomies of scale, highlighting how larger businesses can benefit from reduced average costs but may face challenges in coordination and communication as they grow. The chapter also outlines break-even analysis as a crucial tool for determining the minimum sales needed to cover costs, while noting its limitations due to assumptions that may not hold true.

Uploaded by

remp70115
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© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 16

Cost scale of production & break-even Analysis

Cost is used in making decisions about wother a business should continue or stop produting
a product
You think companies continue producing a product even of a loss? How? Why?

● Fixed costs
● Variable costs
● Total costs

All contected to a business's output (capacity)

Economies and diseconomies of scale


As output (scale) grows, a busines often benefits from the reduced average cost economies
of scale.

Financial economies: large banks prefer to loan big businesses at lower interest rates (as
opposed to smaller banks)

Managerial economies: specialist managers are hired for different departments who
improve quality of work with fewer mistakes than small businesses

Marketing economies: yes marketing budget does increase with larger businesses, but it
does not rise at same level of output. Average cost falls as sales increase.

Purchasing economies: Big businesses buy raw materials in bulk and suppliers lower
prices for them whereas small businesses aren't given the same treatment.

Technical economies: large businesses use flow production which uses latest tech which
can be very expensive and small businesses don't have the money to buy.

Diseconomies of scale
Average cost increases. This happens when a business grows too large and becomes hard
to control due to:

● Poor communication - slow and poor decision-making


● Lack of commitment from employees - demotivated, high labor turnover
● Weak coordination- as # of departments and level of production grows, managers
find it hard to coordinate their objectives. -sometimes resulting in duplicated products,
a waste of resource and an increase in cost.

Break-even Analysis
Business technique that shows the relationship between cost, revenue, and output

● Break-even is the point at which a business's revenue and expenses are equal,
resulting in neither a profit nor a loss. It is commonly used as a benchmark to
determine the minimum level of sales or production that a business must achievein
order to cover its costs. Reached when Total Cost (TC) = Total Revenue (TR)
● The break-even point can be calculated by dividing total fixed costs by the difference
between the price of a product or service and its variable costs. Once a business
reaches its break-even point, any additional revenue will result in a profit.

Used to:

1. Calculate how many #units need to sell before making a profit


2. Calculate the effect on profit of increasing/decreasing the price of product
3. Calculate the effect on profit of an increase/decrease in business costs

Break-even Formula:

Break-even point (in units) = Total Fixed Costs / (Price per unit - Variable cost
per unit)

● For example, if a company has fixed costs of $10,000 and the price per unit is $20
with a varlable cost per unit of $10, the break-even point would be:
● $10,000 / ($20 - $10) = $10,000 / $10 = 1000 units
● This means that the company would need to sell 1000 units to cover its costs and
reach the break-even point.

Limitations of Break-Even Analysis


Calculations are based on assumptions which might not be true. Resülts can be misleading.

● Not everything made is sold -spending patterns change or a business might hold
inventory
● Variable costs might fall as output increases, due to economies of scale
● Prices can change quickly due to competition
● Fixed costs can change as new equipment might be needed to produce more

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