2.2.3 Break Even Flashcards
Define break even
Is the point at which a business is not making a profit or a loss
After reaching break even each additional unit sold will contribute towards
Profit
How do you calculate break even
Fixed cost / contribution
How do you calculate
Selling price - variables
How do you calculate total contribution
Contribution x units
•Before reaching break-even a business is operating at a
Loss
What is contribution
- In business each time a product is sold or service provided what does the money generated contribute towards?
- it has to firstly pay for its own variable costs and then contribute towards the fixed costs
- until there are enough contributions to cover all the fixed costs the business can not start to make a profit
- Each time an item is sold the difference between the selling price and the variable cost is contributed towards the fixed cost
What is the Margin of safety
•Margin of safety is how much actual output is above the break-even level of output
How do you Calculate margin if safety
Actual output level -Break even level of output
Changing variables to keep in mind when handling break even
- Businesses should treat break-even with a degree of caution
- It is based on the assumption that costs and revenues will be static, in reality this is not true
- Businesses are advised to consider the variables that might change and possibly look at a number of scenarios
- Variables can change for the better or worse
- What variables might change?
- Fixed costs
- Landlord puts rent up
- Bank changes interest rates
- Management want pay increase
Strengths of break even
•Allows businesses to calculate the minimum number of sales needed before starting to make a profit and therefore for see if a venture is viable
Can calculate the level of profit or loss at different levels
Can predict the outcome of changing variables
Provides a target
Aids decision making
An integral part of a business plan when seeking finance
Weaknesses of break even
Only indicates the number of sales needed does not ensure actual sales will materialise
Ignores changes in variable costs or selling price as items are bought or sold in larger quantities
•Even fixed costs can vary in reality, especially in the long run
Is an predicted costs and revenue