2.2.3 Break even Flashcards
contribution
Difference between sales revenue and total variable cost
(Important to firms producing a variety of products)
How much sales of a product generates income/contributes towards covering FC then profit
- used to pay firms fixed costs
- once FC paid additional contribution generates profit
Total contribution
Contribution per unit
TR - TVC or CPU x Quantity sold (output)
SPPU - VCPU
-CPU can be increased by either increasing selling price or reducing variable costs
uses of contribution
- decide which product to invest in
- find out if need to raise prices or reduce FC
break even
- a level of output at which total sales revenue is equal to total costs of production
No loss = no profit
break even output
Fixed costs divided by contribution per unit
Break even point is point on the graph of a simple break even analysis
margin of safety
Output at which a business is earning profit
Current output - break even output
impact on break even with
Increase in:
FC
VCPU
SPPU
FC = B Even point becomes higher
VCPU = B even point higher , gradient of TC line steepens
SPPU = B even point become lower
Decrease in SPPU = TR line gradient flatter, B even output = higher
Analysis of break even
Positives
- entrepreneur understand risk
- calculations are quick/easy great
- impact of changing variables on BE and profit
- start up FC minimum
- understand validity of business (and lenders/investors)
- focuses how long will take before start up = profitable
Analysis of break even
Negatives
- Sales are unlikely to be same as output (build up of stock/wasted output
- planning aid not decision making tool
- unrealistic assumption ( products aren’t sold at same price, at different levels of outputs, FC vary when output changes)
- VC don’t always stay same
- MoS sales forecast can prove over optimistic before losses are incurred
- more than 1 product, BE analysis for business = harder to calculate
