Break - even 2.2.3 Flashcards
What does Break even mean?
Break-even is the point at which a business is not making a profit or a loss i.e. it is just breaking even.
At what point does a business Break even?
At the point, total costs are the same as the total revenue
TC = TR
What is Break-even output?
Number of items that a business must sell to reach Break even.
What does margin of safety mean?
The margin of safety is the amount sales can fall before the break-even point is reached and the business makes no profit. This calculation also tells a business how many sales they have made over their break-even point (BEP).
What is the margin of safety eqaution?
Actual output (units) / Breakeven output (units)
How do you improve the margin of safety?
- Increasing contribution:
Raise selling prices
Reduce variable costs per unit - Lower the breakeven output:
Lower fixed costs
Turn fixed costs into variable costs - Increase actual output:
Sell more
What does the word contribution mean?
The amount of earnings remaining after all direct costs have been subtracted from revenue.
In business each time a product is sold or service provided what does the money generated contribute towards?
It has to firstly pay for its own variable costs and then contribute towards the fixed costs until there are enough contributions to cover all the fixed costs the business can not start to make a profit.
What is the equation for Contribution?
Contribution per unit = selling price – variable cost
Total contribution= contribution per unit x number of units sold
What is Contribution per unit?
The difference between selling price per unit and variable cost per unit i.e. how much is left to contribute
Firstly to fixed costs and secondly to profit.
If I sell t-shirts at £11.50 and each one costs me £4.00 to make, what is my contribution?
£7.50 (SP £11.50 – VC £4.00)
What is Total contribution?
Total contribution is the difference between total sales revenue and total variable costs.
If I sell 100 t-shirts total sales revenue is (100 x £11.50) £1150 and total variable cost is (100 x £4.00) £400
What is my total contribution?
£1150 - £400 = £750
How can Contribution per unit be used to calculate break-even?
Fixed cost / contribution = break even
Fixed costs = £60 000
Variable costs = £6.50
Selling price = £25.25
Sales 4000 units
What is the contribution per unit?
£18.75
Fixed costs = £60 000
Variable costs = £6.50
Selling price = £25.25
Sales 4000 units
What is the total contribution?
£75,000
Fixed costs = £60 000
Variable costs = £6.50
Selling price = £25.25
Sales 4000 units
What is the break-even level of output?
3200 units
What does the breakeven chart include?
Total costs and total revenue.
What axis is output measured on?
Horizontal
What axis is revenue, profit and costs measured on?
Vertical
What are 3 things that the breakeven chart show?
Relationship between fixed costs and variable costs as output rises.
Level of output needed to breakeven.
Where a profit and loss are made.
What are limitations of breakeven analysis?
- Unpredictable events meant that results could be inaccurate.
- Assumptions are made about the future.
- May not be able to sell as much as it produces.
- Sales are unlikely to be the same as output – there may be some build-up of stocks or wasted output too.
- Variable costs do not always stay the same. For example, as output rises, the business may benefit from being able to buy inputs at lower prices (buying power), which would reduce the variable cost per unit.
- Most businesses sell more than one product, so break-even for the business becomes harder to calculate.
What are the strengths of breakeven analysis?
- Focuses entrepreneur on how long it will take before a start-up reaches profitability – i.e. what output or total sales is required
- Helps entrepreneurs understand the viability of a business proposition, and also those who will lend money to, or invest in the business
- The margin of safety calculation shows how much a sales forecast can prove over-optimistic before losses are incurred
- Helps entrepreneurs understand the level of risk involved in a start-up
- Illustrates the importance of a start-up keeping fixed costs down to a minimum (higher fixed costs = higher break-even output)
- Calculations are quick and easy – great for giving quick estimates
