5.5

Question 1

what is contribution?

Answer 1

Contribution refers to the money remaining after all direct and variable costs are taken away from the sales revenue. More specifically , contribution is the amount available to ‘contribute’ towards paying fixed costs of production once the variable costs has been deduced.

Contribution can be used to calculate how many products need to be sold in order to cover the firms’ costs.

Question 2

what are the two ways we can devide contribution?

Answer 2

contribution per unit and total contribution.

Question 3

what is controbition per unit?

Answer 3

Contribution per unit – refers to the difference between the selling price per unit and the variable cost per unit (or average variable cost):
𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕=𝑷−𝑨𝑽𝑪

Question 4

what is total contribution?

Answer 4

Total contribution – can be calculated in two ways: by subtracting the total variable cost from the total sales revenue:

𝒕𝒐𝒕𝒂𝒍 𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏=𝑻𝑹−𝑽𝑪
Or :
𝒕𝒐𝒕𝒂𝒍 𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏=𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕∗𝒏𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝒖𝒏𝒊𝒕𝒔 𝒔𝒐𝒍𝒅

𝒕𝒐𝒕𝒂𝒍 𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏=𝑸∗(𝑷−𝑨𝑽𝑪)

Question 5

how can we calculate the profit from the contibution?

Answer 5

profit can be calculated after contribution has been established. To make this calculation we need to know the Total Fixed Cost (FC).
Hence the profit will be the difference between the total contribution and the total fixed cost, as follows:
𝑷𝒓𝒐𝒇𝒊𝒕=𝑻𝒐𝒕𝒂𝒍 𝒄𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏 −𝑭𝑪 **

Question 6

what is the break even point?

Answer 6

The break-even point occurs when the Total Costs (TC) equals the Total Revenue (TR).

Question 7

what is happening in terms of fincances at the break even point?

Answer 7

At the break-even point the firm is not making a profit or a loss, it’s just covering all its costs.

Question 8

why is the break even point important and for who?

Answer 8

Since the aim is to ‘make a profit’, the break-even point is very important for startup companies; since they need to calculate the minimum number or products they need to produce, to cover all their costs.

Question 9

in a break even graph, what are the three possible places a comapny can be in?

Answer 9

Loss – costs of production receding the revenues TC > TR
Break-even – when revenues of the firm equal the costs of production TC = TR
Profit – when revenues exceed the costs of production TR > TC

Question 10

what is the break even chart?

Answer 10

The break-even chart is a graphical method that measures the costs and revenues of the firm against the level of output (sales).

Question 11

waht do we need to consider to make a break even chart?

Answer 11

1- Fixed Costs (FC) need to be paid no matter what level of output; hence they are constant.

3-The Total Cost (TC) starts where the FC line begins (since FC still must be paid even without output produced) – its parallel to the VC

4- With no output sold, there will be no revenue; so, the TR line begins from the origin. The greater the number of units sold the grater the revenue.

5- The break-even point will be where the TC line intersects with the TR one. This point shows both scenarios: break-even cost/revenue and break –even level of output.

6-The chart shows: the loss for the firm (the left side of the break-even point) and the profits made by the firm (the right side of the break-even point)

Question 12

what is important to rember is not included in the break even chart?

Answer 12

for simplicity, the VC is generally NOT INCLUDED in de Break-even chart**

Question 13

what is the margin of safty?

Answer 13

Margin of safety refers to the difference between the break-even level of output and the actual level of output. This margin shows the actual profits the business is actually making.

Question 14

what is the formula for the margin of safty and how may you interpate it?

Answer 14

The greater the difference between the break-even output and the actual output, the saver the firms will be (the greater the safety net).

𝑚𝑎𝑟𝑔𝑖𝑛 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦=𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑜𝑢𝑝𝑢𝑡−(𝑏𝑟𝑒𝑎𝑘−𝑒𝑣𝑒𝑛 𝑜𝑢𝑡𝑝𝑢𝑡)

Question 15

what are the two ways of calculatin the break even quantity?

Answer 15

Using: Total Cost = Total Revenue method

𝑃∗𝑄=𝐹𝐶+𝑉𝐶
𝑃∗𝑄=𝐹𝐶+(𝐴𝑉𝐶∗𝑄)
𝑄=𝐹𝐶/(𝑃−𝐴𝑉𝐶)

Using contribution per unit

BEQ=FC over contibution per unit

Question 16

what can one see on the break even chart in term of profit and loss?

Answer 16

From the break-even chart, we can see that any sales that exceed the break-even quantity generate a profit. Conversely, any sales that are less than the break-even quantity generate a loss.

Question 17

what is the target profit output?

Answer 17

The break-even chart can help determine the level of output that is needed to make profit. This is known as target profit output. This basically refers to how many products you need to sell (i.e. 90 bicycles) to make a profit.

Question 18

what is the formula for the target profit output?

Answer 18

Target profit output can also be calculated by the following formula:

𝑇𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑂𝑢𝑡𝑝𝑢𝑡 (𝑇𝑃𝑂)=(𝐹𝐶+𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡(𝑇𝑃))/(𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)

Question 19

what is the target price?

Answer 19

The target price – is the amount customers need to pay per unit in order for the firm to break-even or to reach a particular target profit.

Question 20

what is the target price formula?

Answer 20

𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 =𝐴𝐹𝐶+𝐴𝑉𝐶
= (𝐹𝐶/𝑄)+AVC

Question 21

what is the target profit?

Answer 21

is the amount (value) of profit that a firm aims to earn within a given time period. The target profit for each level of output can been seen in a break-even chart by comparing the total cost and total revenue lines.
The company determines the TP

Question 22

what is the target profit formula?

Answer 22

using the formula for the TPO and solving for the target profit:
𝑇𝑃=(𝑇𝑃𝑂×𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)−𝐹𝐶

Question 23

what is the break even revenue and how can it be calculated?

Answer 23

Break-even Revenue (BER), which can also be identified in the chart or calculated by the following formula:

𝐵𝐸𝑅=𝐹𝐶/(𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)×𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

Question 24

waht else are BE tequinies helpful for?

Answer 24

Besides helping managers with BE levels of productions and margins of safety; BE techniques can also help managers to make other decisions.
Basically, comparing the ‘actual situation’ with a ‘potential new situation’. However, this needs to be done very carefully since forecast and predictions have to be made.
Specifically, the different situations may affect either the price (hence the revenue) or the cost (either fixed or variable).

Question 25

before you analyse the affect of a chnage in price, what are the key formuals to remeber and how may they be trnselated into mathamatics?

Answer 25

Before analysing the effect of the changes, it is important to remember the following formula:
𝑇𝐶=𝐹𝐶+𝑉𝐶
𝑇𝐶=𝐹𝐶+𝐴𝑉𝐶∗𝑄

Mathematically, this is ‘just’ a linear function:
𝑌=𝑎+𝑏𝑋

Where:
a = intercept
b = slope

Hence:
FC = intercept
AVC = slope

Question 26

what might happen if there is an increase in price?

Answer 26

an increase in price, for example, will help to make a ‘marketing decision’. The price increase will directly affect the Total Revenue (since TR = P*Q)

Using of our linear function, in this case the intercept of the TR will be equal to 0, making P the slope. Hence, the TR will just change its slope .
This means that the sales revenue increased (at any level of output) and the firm will break even at a lower level of output (lower BEQ) with higher profits and an increase in the firms’ margin of safety.

Question 27

what are the effects of chnages in cost in this unit?

Answer 27

– the changes could be either on the fixed costs or the variable costs, and the results will lead to different charts

Question 28

what are the effects of increases in fixed costs for this unit?

Answer 28

this could happen for example when the firm needs to pay a higher rent. Using the linear function, we can observe that in this case is the ‘intercept’ (FC) that is changing. Therefore, the TC will be affected as well. However, in this case both curves are going to ‘shift’ upwards.
The final outcome will be a decrease in profits (at all levels of output), an increase in the BEQ and a decrease in the margin of safety.

Question 29

what are the effects of increases in varible costs for this unit?

Answer 29

if for example wages increase, or the price of raw materials increase, these will lead to an increase in the firms’ variable costs (VC).
Using our linear function again, the change in VC will affect the slope of the TC. Therefore, the TC curve will shift (only changing its gradient).
This leads to an increase in the BEQ and a reduction of the margin of safety.

Question 30

whata re the benifits of break even analasys?

Answer 30

It provides a quick graphical focus on cost and revenue structures in difference scenarios (i.e. helps quickly visualise the impact of changes in costs)

It helps make realistic predictions since Calculations are quick and easy and great for giving quick estimates

Measure profit and losses at different levels of production and sales.
Predict the effect of changes in sales prices.

Analyse the relationship between fixed and variable costs.

Predict the effect of cost and efficiency changes on profitability.

Question 31

what type of business is BE esspeically good for?

Answer 31

BEA is particularly beneficial for business that:
Produce and/or sell a single product
Operate in a single market
All output is sold

Question 32

what are the limmitation of BE?

Answer 32

It can only apply to a single product or single mix of products. It is very difficult to calculate a multiproduct BEA.
Some factors like “staff working overtime” are ignored in the BEA but do affect the cists and revenues of the firm.

BEA assumes that all the output is sold with no possibility of stocking products. In reality, most of the business that can stock produce twill do it (i.e. For sudden changes in demand).

BEA assumes that all costs functions are linear which, in reality, are not. (FC and variable costs can actually change)

BEA does not include semi-variable costs. If it did the analysis will be more complex.

Assumes production and sales are the same. It can’t cope with ‘sudden’ changes in technology, price or cost.

Break even charts may be time consuming to prepare.