2.2.3 - Break Even

Question 1

What is contribution per unit, and how is it calculated?

Answer 1

Contribution per unit is the difference between the selling price per unit of a product and the variable cost per unit of making that product. It is calculated using the formula:

ContributionperUnit = SellingPriceperUnit − VariableCostperUnit

Question 2

How does contribution per unit help cover a business’s costs?

Answer 2

Contribution per unit contributes first to covering the business’s fixed costs. Once the fixed costs are covered, any additional contribution goes towards generating profit.

Question 3

How is total contribution calculated? (2 ways)

Answer 3

TotalContribution = ContributionperUnit × TotalNumberofUnitsSold

OR

TotalContribution = TotalRevenue − TotalVariableCosts

Question 4

What is the difference between total contribution and profit?

Answer 4

Total contribution is the revenue left after covering variable costs, while profit is what remains after fixed costs have also been deducted. Profit is calculated as:

Profit = TotalContribution − TotalFixedCosts

Question 5

What is the break-even point, and how is it calculated using contribution per unit?

Answer 5

The break-even point is the level of sales or output at which total revenue equals total costs, meaning the business makes neither a profit nor a loss. It is calculated using the formula:

Break Even = Fixed Costs ÷ Contribution per Unit

Question 6

What is the margin of safety, and how is it calculated?

Answer 6

The margin of safety indicates how much output can decrease before the business reaches its break-even point. It is calculated as:

MarginofSafety = ActualorCurrentOutput − Break-evenOutput

Question 7

How can a break-even chart be used in business analysis?

Answer 7

A break-even chart shows total revenue and total costs, helping to identify the break-even point.

It can also provide insights into selling price per unit, fixed costs, variable cost per unit, contribution per unit, margin of safety, and whether the business is making a profit or loss.

Question 8

What are the benefits of using break-even analysis in business? (5)

Answer 8

1. Identifying the level of output needed to make a profit, which aids in planning and setting targets.
2. Conducting “what-if” analysis to assess the impact of changes in price or costs.
3. Helping startups understand how much they need to sell to break even.
4. Assisting in business plans to secure finance.
5. Highlighting the importance of keeping costs low.

Question 9

What are the limitations of break-even analysis? (4)

Answer 9

1. It may rely on unrealistic assumptions, such as constant variable costs, which could change with economies of scale.
2. The selling price per unit may vary, particularly with bulk discounts.
3. Sales may not match output, due to stock buildup or wastage.
4. Calculating break-even is more complicated for businesses that sell multiple products.