3.3 Break-even analysis

Question 1

Contribution

Answer 1

the sum of money that remains after all direct and variable costs have been taken away from the sales revenue

Question 2

Formula for contribution per unit

Answer 2

contribution per unit = P - AVC

Question 3

Formula for total contribution

Answer 3

(P - AVC) x Q

Question 4

Formular for profit

Answer 4

total contribution - TFC

Question 5

How can profit be increased?

Answer 5

increase sales of the product
reduce variable costs
reduce fixed costs and overheads

Question 6

What are the uses of contribution analysis?

Answer 6

pricing strategy
product portfolio management
allocation of overheads to cost and profit centres
make-or-buy decisions
special order decisions
break-even analysis

Question 7

Break-even analysis

Answer 7

a management tool that can be used to determine the level of sales that must be made in order to make a profit

Question 8

What are financial conditions a business can be in?

Answer 8

loss = costs of production > revenues
break-even = costs of production = revenues
profit = costs of production < revenues

Question 9

What can BEA inform managers of?

Answer 9

whether it is financiallyworthwhile to produce or launch
a particular good or service
the expected level of profits that the business will earn if
all goes according to plan.

Question 10

How can the BEP be calculated?

Answer 10

TC = TR rule
breakeven = fixed costs / contribution per unit
interpretation for a break-even chart

Question 11

What does the margin of safety measure?

Answer 11

the difference between a firm’s sales volume and the quantity needed to break-even

Question 12

Formula of margin of safety

Answer 12

MOS (output) = level of demand - BEQ

Question 13

How to construct a break-even chart?

Answer 13

1. draw and label the total fixed costs line
2. draw and label the total costs line
3. draw and label the total revenue line
4. x-axis is labelled as the output
5. y-axis is labelled as the ‘costs and revenues’
6. title of the chart

Question 14

What factors may lead to a change in the profits or losses compared to the ones in break-even?

Answer 14

the difference between short-term and long-term profits
the level of demand is subject to change
profit depends on the level of risk involved
innovation and the introduction of new technologies
luck

Question 15

Which businesses are BE particularly beneficial to?

Answer 15

produce/sell a single standardised product
operate in a single market
make products to order (all output is sold)

Question 16

Why are limitations of break-even models?

Answer 16

assumes that all costs are linear
assumes the sales revenue is linear
assumes that the business will sell of their products
a static model