10. Breakeven Analysis & Limiting Factor Analysis

Question 1

What is meant by breaking even?

Answer 1

Where generated revenue is equal to total costs

Question 2

What is breakeven analysis?

Answer 2

Breakeven analysis (or cost-volume-profit (CVP)) is the study of the interrelationships between costs, volume and profit at various levels of activity

Question 3

Define breakeven point. Give the equation

Answer 3

The number of sales units needed to break even (revenue is equal to total costs)

Question 4

Define breakeven revenue. Give the equation

Answer 4

The revenue needed to break even (revenue is equal to total costs)

Question 5

Define contribution to sales ratio (C/S ratio)

Answer 5

Contribution per unit divided by sales price per unit - also known as the profit/volume ratio

Question 6

Define margin of safety. Give the equations (2)

Answer 6

A measure of how much sales would need to drop by before a loss is made and can be calculated either in units or £ or as a %

Question 7

Define the equation to calculate the number of unit sales required to achieve a target profit

Answer 7

Question 8

Define the equation to calculate the revenue required to achieve a target profit

Answer 8

Question 9

Outline a breakeven chart and illustrate all the key points on it

Answer 9

Question 10

Outline the disadvantages of breakeven analysis (4)

Answer 10

• It can only apply to a single product or a constant mix of a group of products
• It may be time-consuming to prepare
• It assumes that sales price per unit, variable cost per unit and total fixed costs are constant at all levels of output
• It assumes we produce the same number of units as we sell .

Question 11

What is limiting factor analysis?

Answer 11

Analysis technique that helps maximise contribution by allocating a scarce resource (the limiting factor) to producing goods that earn the highest contribution per unit of scarce resource available

Question 12

Outline the method for simple limiting factor analysis

Answer 12

METHOD

Question 13

How does the optimum production plan produced through limiting factor analysis differ if an extra supply of the limiting factor becomes available?

Answer 13

We can use limiting factor analysis to help decide how much a business would be willing to pay to buy those extra units of resource - the maximum premium a business would be willing to pay (in addition to the usual purchase price) to acquire extra units of a limited resource would be the additional contribution it could earn by using those additional units.

Question 14

Outline the method for limiting factor analysis where an extra supply of the limiting resource becomes available

Answer 14

METHOD

Question 15

How does the optimum production plan produced through limiting factor analysis differ if there is a restricted freedom of action?

Answer 15

In certain circumstances an organisation may also be restricted by a factor other than a scarce resource, for example:
* A contract to supply a certain number of products to a customer which cannot be cancelled
* Production/sales of a minimum quantity of one or more products to provide a complete product range and/or to maintain customer goodwill
* Maintenance of a certain market share of one or more products

In each of these cases, the organisation might have to produce more of a particular product or products than the level established by ranking. In this instance, the products should be ranked in the normal way but the optimum production plan must first take into account the minimum production requirements.

The remaining resource must then be allocated according to the ranking.

Question 16

Outline the method for limiting factor analysis where there is restricted freedom of action

Answer 16

METHOD

Question 17

How does the optimum production plan produced through limiting factor analysis differ if there is the possibility of outsourcing?

Answer 17

An organisation might want to do more things than it has the resources for, and so it may seek to combine internal resources with subcontracting externally so as to do more and increase profitability

Therefore a further decision is then required on which parts of the work should be given to suppliers or subcontractors so as to maximise profitability.

In a situation where a company must subcontract work to make up a shortfall in its own in-house capabilities, its total costs will be minimised if those units bought have the lowest extra variable cost of buying per unit of scarce resource.

Question 18

Outline the method for limiting factor analysis where there is a need to outsource

Answer 18

METHOD