6. Measuring the Potential Success of a Business Idea

Question 1

what is break even and how is it calculated?

Answer 1

• total costs=total revenue
• it isn’t making s profit but it’s no longer making a loss
• it’s a measure of the amount that each product can contribute towards the fixed cost of production

how to calculate BE using contribution:
FC / contribution

Question 2

what are profit and loss accounts used for?

Answer 2

• it’s a legal requirement
• it summarises the year’s transactions
• shows the financial health of the business
• can be used to compare profit over a number of years

Question 3

describe fixed costs and how to calculate the total fixed costs

Answer 3

• fixed costs do not change with the amount produced
• they are also known as indirect costs e.g. rents, rates or overheads
• these have to be paid regardless of whether the good or service is made or sold
• total FC = all fixed costs added together

Question 4

describe the variable costs and how to calculate the total variable costs

Answer 4

• variable costs change with the level of output
• if output increases–> the variable costs increase
• if output decreases–> the variable costs will decrease
• also known as direct costs e.g. raw materials, packaging
• TOTAL VC = VC per unit X output

Question 5

what are the average costs and how are they calculated? how is it used by firms?

Answer 5

• average costs are the costs of making 1 unit/ item
• actual costs = total costs/quantity
• many firms use cost-plus pricing to set a price for their product i.e. AC + markup

eg £2 + 20% would give a selling price of £2.40

Question 6

what is a profit margin and how is it calculated?

Answer 6

-a profit margin calculated the percentage of sales revenue that is profit

profit margin = (profit ➗ sales revenue) x 100

Question 7

how do you calculate contribution?

Answer 7

price - variable costs

P-VC