Break even analysis Flashcards
What is break even?
Another tool to aid in the decision making process.
- It is used to find the level of output necessary to cover all costs.
- Break even is the point where total revenue covers (is equal to) the total costs. - TR=TC - at this point all costs have been covered.
What is the margin of safety?
The difference between the actual level of output and the break-even level.
What is the target level of profit?
A goal for businesses. Once the breakeven level is calculated it is possible for a business to decide on a required level of profit (target level).
What is the formula for break even output?
Fixed costs/contribution per unit
What is the formula for contribution per unit?
Selling price - variable cost (per unit)
What is the formula for total contribution?
Total revenues - total variable costs
What is contribution?
What a business needs to achieve from selling products in order to first cover its fixed costs, and thereafter make a profit.
Once contribution has covered fixed costs, the business can make a profit.
What is break even always expressed is?
Units
What is the formula for targeted level of profit?
Non-current costs (fixed costs or overheads) + target profit / contribution per unit
What are the strengths of breakeven?
- Focuses entrepreneur on how long it will take before a start-up reaches profitability
- Helps entrepreneur understand the viability of a business proposition, and also those who will lend money to, or invest in the business.
What are the limitations of breakeven?
- Unrealistic assumptions - products are not sold at the same price at different levels of output - fixed costs do vary when output changes.
- Variable costs don’t always stay the same. e.g. as output rises the business may benefit from being able to buy inputs at lower prices (buying power) which would reduce variable cost per unit.
