2.2.3 - Break Even Flashcards
What is the break-even point?
The break-even point is the level of sales at which a business’s total revenue equals its total costs. At this point, the business covers its costs but makes no profit.
What happens when sales are below the break-even point?
When sales are below the break-even point, costs exceed revenue, and the business makes a loss.
What happens when sales are above the break-even point?
When sales are above the break-even point, revenue exceeds costs, and the business makes a profit.
Why is break-even analysis important for new businesses?
It helps new businesses determine how much they need to sell to cover their costs and can be used to convince lenders about the viability of the business.
How is contribution per unit calculated?
Contribution per unit = selling price per unit - variable cost per unit.
What is total contribution used for?
Total contribution (from all units sold) is used to pay fixed costs. The remaining amount, if any, is profit.
How do you calculate the break-even point using contribution per unit?
Break-even point = total fixed costs ÷ contribution per unit, or Break-even point = total fixed costs ÷ (selling price per unit - variable cost per unit).
What is shown on a break-even chart?
A break-even chart shows costs and revenue plotted against output, with fixed costs, total costs, and revenue lines plotted on the graph.
How do you use a break-even chart to calculate profit or loss?
Find the total costs and revenue at your chosen output level on the chart. Subtract total costs from revenue: if the result is negative, it’s a loss; if positive, it’s a profit.
How does changing the price of a product affect the break-even point?
When prices increase, the revenue line becomes steeper, lowering the break-even point. You don’t need to sell as many units to break even.
What is the margin of safety?
The margin of safety is the difference between actual output and break-even output. It shows how much sales can fall before the business starts making a loss.
How is the margin of safety calculated?
Margin of safety = actual output - break-even output.
Why is a large margin of safety useful for a business?
A large margin of safety reduces risk, as the business can absorb a drop in sales before it starts making a loss.
What are the advantages of break-even analysis?
- It’s easy and quick to do.
- Helps businesses forecast how changes in sales, price, and costs will affect profits.
- Useful for persuading lenders or investors.
- Influences decisions on whether to launch new products.
What are the disadvantages of break-even analysis?
- Assumes variable costs always rise steadily, which may not be true.
- More complex for businesses selling multiple products.
- Results are inaccurate if the data is wrong.
- Assumes no waste or unsold products, which may not be realistic.
- Doesn’t predict how many units will actually be sold, only how many are needed to break even.
