Colorado State University Extension. 9/92.
F A R M
R A N C H
S E R
I E S
is a useful tool to study the
relationship between fixed costs,
variable costs and returns. A
break-even point defines when
an investment will generate
a positive return and can be
determined graphically or with
simple mathematics. Break-even
analysis computes the volume
of production at a given price
necessary to cover all costs.
Break-even price analysis computes
the price necessary at a given level of production to cover all costs. To explain
how break-even analysis works, it is necessary to define the cost items.
Fixed costs, incurred after the decision to enter into a business activity is
made, are not directly related to the level of production. Fixed costs include, but
are not limited to, depreciation on equipment, interest costs, taxes and general
overhead expenses. Total fixed costs are the sum of the fixed costs.
Variable costs change in direct relation to volume of output. They may
include cost of goods sold or production expenses such as labor and power
costs, feed, fuel, veterinary, irrigation and other expenses directly related to the
production of a com modity or investment in a capital asset. Total variable costs
(TVC) are the sum of the variable costs for the specified level of production or
output. Average vari able costs are the variable costs per unit of output or of TVC
divided by units of output.
Total fixed costs are shown in Figure 1 by the broken horizontal line.
Total fixed costs do not change as the level of production increases. Total variable
costs of production are indicated by the broken line sloping upward, which
illustrates that total variable costs increase directly as production increases.
The total cost line is the sum of the total fixed costs and total variable
costs. The total cost line paral lels the total variable cost line, but it begins at the
level of the total fixed cost lin