When to use it:
- understanding types of costs, pricing
- understanding how to compute break-even point
- understanding how production, sales and profit are related
Size of the group: 6 to 15 people
Age of the group: over 14 years old
Preparation: 30 min.
Presentation: 1 hour – 1 hour 30 min (depending on the size of the group and their level of knowledge in regards to maths formulas and basic economic concepts)
- A4 papers
- three flip-chart papers
- You split the participants in groups of three.
- Tell the participants the following story: “You discovered you are a talented cook, and your are great in cooking carrot cake; you sold your first carrot cake last week to your aunt, and she started to promote you, and now everyone calls asking for carrot cake – family, friends, neighbour. After two months of intensive carrot cakes cooking, you decide to open a small business, rent a place and cook and sell carrot cake more professionally. You meet your wise friends for a coffee, and ask them to help you with deciding over costs and prices”.
- Ask each group to make a list with the costs they can think a small business like that will have. At the same time, ask them to think to a price they will put on the carrot cake.
- Each group will present then the costs they identified, while you are taking notes on a flipchart paper split in two, with fixed costs and variable costs. Explains the participants the differences between the two types of costs.
- Ask each group how they decided on pricing. Explain the participants that there are three ways of setting prices for products – based on costs, based on what clients are willing to pay, or a combination of these two strategies.
- Starting from the discussions, and the things they mentioned while explaining their strategy for pricing, explain the concept of profit. Make it simple, and explain that profit represents the difference between revenues / sales and costs; write on a flipchart paper the formula: Revenues-Costs=Profit.
- Ask now the groups if they know how many carrot cakes per month their friend should make in order to reach the break-even point. Explain the break-even point as the point where Revenues equalize Costs, the point from which the small business starts making profit.
- Demonstrate how the break-even point is computed using the costs and prices they provided previously, or using the following example:
If for one carrot cake, the variable costs are 2 euros, and the monthly fixed costs for the business are 2000 euros; and the price set for one carrot cake is 10 euros, here is how break-even point is calculated:
Revenues/Sales=Costs, and x=the number of carrot cakes needed to be produced and sold
In conclusion, the friend has to cook 250 carrot cakes/month; which means more than 11 carrot cakes per working day.
- Explain the participants that this is just an example, but any beginner in entrepreneurship should his/her business by calculating this break-even point, and make a rational decision and find solutions to optimize costs and production, and/or increase prices.
- Now, ask the participants to exercise this formula, but this time they should calculate how many carrot cakes must be produced and sold, if their friend needs a profit of 4000 euros/month. Provide the starting formula on a flip-chart paper: Revenues-Costs=4000 euros. Give them 10 minutes to do the math.
- Ask participants about the numbers they obtained, and quickly demonstrate on the flip-chart paper the calculations:
- Recap with the help of the participants the main concepts: costs (variable, fixed), break-even point, profit. Insist on the idea that an entrepreneur can optimize his / her profit by applying different strategies on costs, production, pricing, and sales.
- What will you do if you were the talented cook from the story? What will be your decisions in regards to opening the business, and what are the factors that could and should influence your decision?
You can adapt the type of business / product you use in your example accordingly to the group you work with.
How to do a break-even analysis