3.3 Break even Flashcards
Break even?
The level of output at which total costs equal total revenue
The formula for Break-Even?
Fixed cots/contribution per unit (price -VC)
What is the equation for total contribution?
Total revenue – Total variable cost
What is the equation for contribution per unit?
Price per unit – Variable cost per unit
Where is the break-even point on a break-even chart?
The intersection of Total Cost and Total Revenue
by calculation: BE quantity (units) * price
How do we get the Total revenue?
Price x output
What does the margin of safety show?
Shows how much demand exceeds or fails to exceed BEQ
What is the equation for margin of safety?
Sales volume (Current or Projected Demand/sales/output) – BEQ
Title of break even chart
Break Even Analysis for Company XYZ
Label axes
X-axis is output
Y-axis is Revenue/Cost (label currency as well)
Draw Total Revenue line
Starts at (0,0), intersects BEP
Draw Total Cost line
Starts at Fixed Costs and takes the slope of VCs, intersects the BEP
How do we calculate the BR revenue?
BEQ * price
Limitations of BE
Makes several assumptions:
Fixed costs must be paid regardless of the output
Variable cost increases linearly
Ignores economies of scale
Sales revenue increases linearly
Ignores discounts for large orders and price discrimination
Assumes only one product is sold
Every unit of output is sold
The selling price is constant regardless of units sold
Provides a static model (e.g. in real life production costs can change)
Depends on reliability of data
Other factors can have an effect (e.g. competitors, staff motivation)
Less suitable for multi-product lines
What does the break even help to find?
Helps to tell whether a good can be financially worthwhile and the level of profit a business is likely to earn
What does the BE ignore when calculating level of sales needed to attain a certain profit?
Ignores other factors that affect profit:
Different pricing throughout time
Level of demand is subject to change
Profit depends on risk
Innovation and luck – prediction aren’t always followed
What does the BE have to consider when calculating level of sales needed to attain a certain profit?
Pricing strategies (penetration pricing, market skimming, etc.)
Price elasticity
What is the formula to calculate the (target) output with given price and profit?
output= (Fixed costs+profit)/contribution per unit
What is the formula to calculate (target) profit with given (target) output and contribution per unit?
output= (Fixed costs+profit)/contribution per unit
Farther:
FC+profit=CPUoutput
Profit=CPUoutput-FC
What is the formula to calculate the (target) price with given output and profit?
(Fixed costs+profit)/Price - VC=output
or
Farther:
price=(FC+profit+output*VC)/output
Can a company have a negative margin of safety?
yes, if the current output is below the BEQ
Can we express the margin of safety by %?
Yes, the difference between the current and BEQ/sales
What do we have to necessarily indicate on the chart?
- The lines of TC, TR,
- the BE point itself! point by the arrow!
- the numbers on both axes must be sufficient to be scalable (take the BEQ and BER first on both axis, take more or less in the center; measure logically where would be the FC line or any other given data and write some additional numbers based on logic, like 30, 40, 50 on the x axis)
How will the change in price affect BEQ?
With higher price:
less quantity is needed to break even.
TR line becomes steeper
Margin of safety increases
With lower price - the reverse happens
How will the change in costs affect BEQ?
In the case of changes in FCs:
the starting point of TC shifts up (the slope remains the same)
and BEP shifts up and right, increasing the need of more output and revenue to brek-even
In the case of VC:
the starting point of the TC remains the same but
The slope becomes steeper and touches the TR in the upper and more right area, increasing the BEQ and BER
In both cases more output is needed to break even and in both cases the margin of safety is reduced
