28 Break-even analysis

Question 1

Define break-even point

Answer 1

Level of output where total costs and total revenue are exactly the same - no profit or loss is made

Question 2

Contribution per unit formula

Answer 2

Selling price - variable cost per unit

Question 3

Break-even point formula

Answer 3

Fixed cost / contribution per unit

Question 4

Define margin of safety

Answer 4

The amount of sales that can fall before the break-even point is reached and the business makes no profit

Question 5

Margin of safety formula

Answer 5

Margin of safety = actual sales − break-even sales

Question 6

Define break-even chart

Answer 6

A graph drawn to show the break even point, profit, loss and margin of safety

Question 7

State the advantages of a break-even chart

Answer 7

• Informs a business how many units they need to sell a break-even
• Provides a target for managers and employs to focus on
  
  • Can increase motivation
• Can determine the margin of safety (actual sales - break-even point)
• Can help to attract investors
• Can secure finance from a bank as it offers reassurance
• Can aid in decision making
  
  • E.g. can help business decide whether product is worth launching
• Helps business analyse changes

Question 8

State the disadvantages of a break-even chart

Answer 8

• Fixed costs can change in the longer term (e.g. rent is increased)
• Variable costs can change (e.g. suppliers increase their prices)
• Doesn’t work if the business has more than one product
• Not very good for services as prices can vary enormously