11.1 Breakeven analysis

Question 1

CVP analysis makes use of

Answer 1

The contribution concept in order to assess the following measures for a single product
- Contribution to sales ratio (C/S)
- Breakeven point
- Margin of safety

Question 2

C/S ratio (aka P/V profit / volume ratio)

Answer 2

• The contribution to sales ratio is a useful calculation in CVP analysis (usually expressed as a %)

C/S ratio = Contribution per unit / Selling price per unit OR Total contribution / Total sales revenue

Question 3

Breakeven point

Answer 3

• Where total costs equal total revenue (neither a profit or loss is made)

Total sales revenue = Total costs

Total contribution = Fixed costs

Question 4

Break even calculations:

Answer 4

• Number of units sold = Fixed costs / Contribution per unit
• Sales revenue = Fixed costs / C/S ratio OR Breakeven point in units x Selling price per unit

Question 5

Where a certain amount of profit is required

Answer 5

• The breakeven formulae can also be used to calculate the level of activity required to generate it = Fixed costs + required profit / Contribution per unit
• OR sales revenue required = Fixed costs + required profit / C/S ratio
• OR = Breakeven point in units x Selling price per unit

Question 6

The margin of safety is the

Answer 6

• The amount by which anticipated sales (in units) can fall below budget before a bus makes a loss
• It can be calculated as number of units or a percentage of budgeted sales

Margin of safety in units = Budgeted sales units - Breakeven sales uits

Margin of safety % = Budgeted sales units - Breakeven sales units / Budgeted sales units x 100

Question 7

Single product break even charts

Answer 7

The info from CVP analysis can be represented in a breakeven chart which will show:
- The breakeven point in units
- Breakeven point in revenue
- Total fixed costs
- Total costs
- Margin of safety
Deals with total revenue and costs and individual revenue and costs would be difficult to determine

Question 8

The contribution break even point

Answer 8

• Based on the same principles as basic breakeven chart but also shows the variable cost line instead of the fixed cost line
• Breakeven point and profit can still be read but can also read contribution for any level of activity
• Used when highlighting the importance of contribution and focus attention on variable costs

Question 9

The profit volume chart (aka profit graph or contribution volume graph)

Answer 9

• Shows the profit or loss at any given activity
• Assuming constant selling price and variable unit costs at all volumes of output the profit volume chart shows profit or loss as a single straight line
  -The breakeven point is where this line cuts the horizontal axis
• Main advantage of this chart is to determine the effect on profit and breakeven point if any changes in variables
• The steeper the slope the higher the contribution per unit

Question 10

Multi product break even analysis

Answer 10

• Different products will have different selling prices, costs and contribution margins therefore breakeven point will depend on the mix in which various products are sold
• In order to cope with this CVP analysis assumes that if a range of products is sold, sales will be according to a pre determined sales mix and this will remain constant

Question 11

Multi product breakeven analysis calculation

Answer 11

• The numerator remains the fixed costs but the denominator becomes the weighted average C/S ratio (revenue) or weighted average contribution (units)

Weighted average C/S ratio = Total contribution / Total revenue

Breakeven (revenue) = Fixed costs / Weighted average C/S ratio

Breakeven (units) = Fixed costs / Weighted average contribution

Question 12

Establishing a target profile for multiple products

Answer 12

Approach is same except the weighted average contribution to sales ratio is used

Revenue required = Fixed costs + Required profit / Weighted average C/S ratio

Question 13

The multi product profit volume graph

Answer 13

Two lines must be shown:
- One straight line, where a constant mix between the products is assumed
- One bow shaped line, where it is assumed that the company sells its most profitable product first (highest C/S ratio = steepest line) and then next most profitable and so forth

Question 14

Sensitivity (what if) analysis of CVP model

Answer 14

• Involves changing the constants, ie prices, variable cost per unit, sales mix ratio, etc to determine the effects of changes
• The sensitivity of revenue to various outcomes broadens the perspective of management regarding what might actually occur before making cost commitments

Question 15

Advantages of CVP analysis

Answer 15

• Provides a target volume
• Helps the understanding of costs and revenues and the relationship between them

Question 16

Disadvantages of CVP analysis

Answer 16

• Profits can be affected by other factors besides volume
• A small change in the assumptions could have a large change in the outcome

Question 17

Advantages and disadvantages of breakeven analysis

Answer 17

• Indicates lowest activity necessary to prevent losses
• Based on many assumptions about cost behaviour that may not be true
• Profits affected by other factors

Question 18

Reducing operational gearing means

Answer 18

• Converting some fixed costs into variable costs
• This will reduce the level of fixed costs and increase the level of variable costs
• Increasing variable costs will decrease the contribution per unit and the C/S ratio

Question 19

Org with a higher level of operational gearing will have

Answer 19

• A higher breakeven point than org with lower gearing
• Org with lower gearing will have a lower breakeven point lower contribution to sales ratio and lower levels of fixed costs