2.2.3 Breakeven And Contribution

Question 1

Contribution

Answer 1

The difference between sales revenue and total variable costs. It is used to pay the firms fixed costs. Once fixed costs are paid, additional contribution generates profit.

Question 2

Contribution per unit formula

Answer 2

Selling price per unit - Variable cost per unit

Question 3

Total contribution formula

Answer 3

Contribution per unit x Quantity sold

Question 4

Profit formula

Answer 4

Total contribution - Fixed costs

Question 5

Advantages of contribution

Answer 5

• Helps with allocation of fixed costs to see which product contributes more.
• Costing and pricing this way is simple to operate.
• Looks at the whole business.
• Can be adjusted when changes occur.

Question 6

Disadvantages of contribution

Answer 6

• Difficult to classify costs into fixed or variable.
• Can be easily confused with profit.
• Can only be used in the short term when fixed costs do not change and output is fixed for a certain period of time.

Question 7

Breakeven

Answer 7

A level of output at which total sales revenue is equal to the total costs of production. The business doesn’t make a loss but also doesn’t make a profit.

Question 8

Breakeven output formula

Answer 8

Fixed costs / Contribution per unit

Question 9

Margin of safety

Answer 9

The difference between the actual level of output of a business and its breakeven level of output.

Question 10

Margin of safety formula

Answer 10

Actual output - Breakeven output

Question 11

Advantages of Breakeven

Answer 11

• Helps entrepreneur understand the level of risk involved in a start-up.
• Calculations are quick and easy.
• How long it will take for an entrepreneur to break even.
• Hypothesise impact of changing variables on breakeven.
• Margin of safety calculations shows how much a sales forecast can prove over-optimistic before losses are incurred.
• Helps entrepreneur understand the viability of a business, also those who will lend money to, or invest in the business.
• Illustrates importance of keeping start-up costs to minimum to a business.

Question 12

Disadvantages of breakeven

Answer 12

• Unrealistic assumptions – products are not sold at the same price at different levels of output; fixed costs will vary as output changes.
• Variable costs do not always stay the same.
• Harder to calculate when businesses sell more than one product.
• Sales are unlikely to be the same as output.