3.5.2 - Analysing Financial Performance - Break Even

Question 1

Define contribution

Answer 1

The difference between sales revenue and the variable costs of production

Question 2

Define contribution per unit

Answer 2

The difference between the selling price of one unit and the variable cost of producing one unit.

Question 3

Define total contribution

Answer 3

Contribution per unit x the number of units sold

Question 4

What is the break - even level of output?

Answer 4

The level of output/the number of customers where the total revenue is equal to the total costs of the business.

Question 5

What is the margin of safety?

Answer 5

The amount by which the existing level of output is greater than the break - even point.

Question 6

How do you calculate break even?

Answer 6

Break even output = fixed costs/contribution per unit

Question 7

How do you calculate contribution per unit?

Answer 7

Contribution per unit = Selling price per unit - variable cost per unit

Question 8

How do you calculate total contribution?

Answer 8

Total contribution = contribution per unit x number of units sold

Question 9

What does contribution contribute towards first?

Answer 9

Fixed costs.

Question 10

Once fixed costs have been paid off by the contribution, what does the contribution become?

Answer 10

Profit.

Question 11

What are the benefits of break even analysis to managers?

Answer 11

• Helps them to plan and operate their business
• Helps them to select the appropriate operating output
• Helps them to establish the viability of a new project (the risks associated with a new project)
• Helps to provide evidence of viability when applying for external finance (e.g a loan)

Question 12

What are the strengths of break even analysis?

Answer 12

1. Calculations are quick and easy
2. Focuses entrepreneur on how long it will take before a start-up reaches profitability
3. Helps entrepreneur understand the viability of a business proposition
4. Helps entrepreneur understand the level of risk involved in a start-up

Question 13

What are the limitations of break even analysis?

Answer 13

1. Assumptions are not realistic as it assumes that all output that is produced is sold.
2. It is only a planning aid so should not be used as a definite decision making tool
3. Inaccuracies in the data will lead to incorrect break even forecasts
4. Many businesses sell more than one product (different selling prices)