1.6.2 The relationship between Revenue and Costs Flashcards
How is contribution per unit calculated?
selling price of one unit - variable cost on one unit
What is break even analysis
This is used by businesses to analyse what number of goods and services they must sell in order to be profitable. Break even is always given as a value of output, not price.
When does break even occur?
When total costs is equal to total revenue. Hence the business is making neither a loss or profit and are breaking even.
Break even analysis
diagramtically
Fixed costs are a horizontal line and do not increase, remain constant.
Total revenue is a straight line increasing from the origin.
Total costs is also a straight line and starts from the same point as fixed costs.
When total costs and total revenue intersect, is the point of break even. Anything above point of intersection=profit, anything below=loss.
How can break even point be calculated?
Break even point may be seen diagrammatically however can also be calculated: Total fixed costs / contribution per unit.
always round up if decimal value calculated
How may a business calculate revenue gained at break even point
Revenue at break even point= sales volume at break even point x selling price.
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What is margin of safety?
This is the difference between what the business is actually selling in terms of volume of output and the volume of output at break even point. Margin of safety is usually positive as if not then there is no margin of safety. If margin of safety is 0 then business is producing sales volume at the break even point. When +ve then sales volume is greater than break even point.
How is margin of safety calculated?
sales volume the busniess is producing - break even point.
What are some limitations of using break-even analysis
Doesnt take into account any external factors which are out of the business control e.g state of economy or regulation.
Doesnt take into account the idea which fixed costs may actually change in the long run.
Break-even graphs show revenue increases as price increses however this is not always true due to the law of demand, price increasing will likely cause for demand to fall so revenue at some point will also fall.
