3.3 Flashcards
Break even definition
is a common business management tool used by start- ups and firms deciding on whether to invest in certain projects or products.
It is used to determine the level of sales needed in order to cover all the costs associated with the output of a particular good or service.
Contribution definition
Is the surplus of revenue over variable costs a business makes that goes towards paying fixed costs.
Total contribution definition
Is found by subtracting the total variable cost from total sales revenue
Only takes away variable costs from sales revenue
Total contribution formula
Total contribution = total revenue-total variable cost
Contribution per unit definition
Is the surplus of the selling price of a product over the unit variable cost of producing it
The contribution per unit is a useful financial statistic because it tells a businessthe financial implications of selling more units or fewer units
Contribution per unit formula
Contribution = selling price per unit - variable cost per unit
(P-avc)
Total contribution by contribution per unit
Total contribution = contribution per unit x number of units sold
(P-avc) x p
Used to pay fixed costs
The difference between firm’s selling price and its average variable cost
Break -even occurs when
A firms total contribution equals to total fixed costs
Profit or loss by contribution
When you take away fixed costs from total contribution
Profit= [ (p-avc) x q]-Tfc
Revenue formula
Price x quantity
Total costs formula
Fixed costs + variable costs
Variable costs formula
Variable x quantity
Profit/loss formula
Revenue- total costs
Increasing profit
- increasing sales of the product,which raises the total contribution (gross profit)
- reducing fixed costs, perhaps through negotiating better deals with current suppliers or seeking new suppliers that are more competitive
- reducing fixed costs and over heads, perhaps through better financial control or the use of costs and profit centres
Unit contribution vs value added
Unit contribution = price - average variable costs
P-avc
Value added per unit = price - average total costs
P-ate
Value added Considers both variable and fixed costs of production
Aunt contribution only considers the cost of goods sold (COGS) or the variable cost
6 ways contribution analysis is useful for businesses
Pricing strategy - helps set prices for each product so enough contribution is made towards payment of fixed and indirect costs
Product portfolio management- helps managers decide whichproducts should be investment priority
Allocation of overheads to cost and profit centres
Make-or-buy decisions - can help businesses decide whether it should produce the product on buy them from suppliers
Special order decisions -when customers place an order at a price that differs from the normal price changed by the business e.g. Buys more the analysis help making decisions
Break even analysis
Break-even quantity definition
The level of output of which total costs equal total revenue
Margin of safety
The amount in which sales level exceeds the break- even level of output
Break-even revenue
The remount of revenue needed to cover both fixed and variable costs so that the business breaks even
Break even quantity x price
Business can be only in one of the situations of art point in time
Loss- when cost of production exceed the revenues of business
Break-even-when the revenues equal the cost of production
Profit- when revenues exceed cost of production
Break-even analysis definition
Business planning tool that applies costs and revenue data to support decision making
Especially important for startups on businesses engaging in new ventures so as to establish the minimum number of products they need to sell to cover all their costs
Break-even term
Refers to the level of outputs a firm needs to achieve where total revenue equals total costs and the business starts to make profit
Break-even chart
Graphical representation of the costs and revenues associated with producing a good or service. The break-even point can be identified by plotting the total cost and toted revenue figures on a graph
What is plotted on a break-even chart
Fixed cost-always straight one, must be paid whether a firm produces anything or not
Total cost-varies as it includes variable cost which varies in direct proportion to output
Sales/revenue- obtained by multiplying selling price by output level /quantity
The break -even point (bep)
Is where the toted costs and sales revenue lines cross
The break- even quantity
Level of output where a business does not make either a profit or a loss
General Formula
Fixed cost /selling price- average variable cost
Break even formula using contribution
Fixed costs/ contribution per unit
Or
Fixed cost/price per unit- variable cost per unit
Break-even quantity using total cost= total revenue
Tr = price per unit (p) x quantity (q)
Tc= total fixed cost (tfc)+ total variable cost (tvc)
Tvc = variable cost per unit (vc) x q
Thus
P x q = tfc +tvc
Margin of safety
The difference between the actual output or the target level of output a business aims to achieve and the break even quantity or output
Indicates how much sales could fall without the firm falling into loss
Formula
Level of demand - break - even output
Target profit output/ quantity
The quantity of sales required to reach the firms target profit
Formula
Fixed costs + target profit/ selling price - average variable cost
Target profit
Is the amount of profit that a firm aims to earn within a given time period. The target profit for each level of output can be seen in a break-even chart by comparing the total cost and revenue lines
