Break even analysis Flashcards
What is unit contribution formula?
sale Price- variable cost per unit
What are the 2 formulas for total contribution?
Contribution X number of units
Sales revenue – total variable costs
What is contribution used for?
Prioritise output and make decisions
Calculating profit
How can contribution prioritise output and help make decisions?
Useful for a business that sells multiple products or services to see which contribute more to overall business
What is the formula for calculating profit from contribution?
Profit= total contribution–Total fixed costs
What would the contribution be if selling price was 35 and variable cost per unit was 37?
(2)
What would total contribution be if contribution per unit was 7 and # of unit sold is 100?
700
What would the profit of a business be if output is 500 units, contribution per unit is 5 and fixed costs are 1200?
1300
What is the break even point?
level of sales/ output where total costs are equal to total revenue
If the business making a profit or loss when at break even point?
neither
What does it mean if output is below break even point?
a loss will be made
What does it mean if output is above break even point?
profit is made
Why do firms use break even analysis?
Calculate in advance sales needed to break even
See how changes in sale/output affect profit
Changes in cost price affect breakeven and profit
Level of output/sale needed to reach target profit
What is the formula for breakeven point?
Total fixed costs/Unit contribution (selling price- variable cost)= Units
What is the breakeven point if fixed costs are £60,000and contribution is £60?
1,000 units
What is the break even safety margin?
the margin of safety is the amount by which sales exceed the break-even point
What is the margin for safety if the breakeven point is 300 and current production is 400?
100
33.33% (production above break even point/ unit to break even x100)
What would profit be if total safety margin is 8 and contribution per unit is 126.5?
1012
What 3 considerations must a business bear in mind when establishing pricing policy?
Establishing an acceptable return on capital
Understanding the relationship between fixed and variable costs
Knowing the price that the market will bear
What must you do when using the considerations for pricing policy?
Cannot be considered independently must all be taken into account
What must be considered when deciding an acceptable return on capital for pricing policy?
Business objective of giving suitable return to investors
Investors will withdraw their funds if better opportunities elsewhere
Sufficiently high selling price should be established to provide adequate return
How should special orders be priced?
less than absorption cost but above marginal cost
What does a business need to do to make a profit? (break even)
selling price needs to be set so that fixed costs are more than covered by the contribution from sales any surplus after fixed cost is profit
Example of why relationship between fixed and variable costs must be understood?
Possible to carry out manufacturing process in 2 different ways 1.labour intensive (few inexpensive machines) 2.costly machines but few operators
First method- variable cost high but fixed costs are low
Second method- variable costs low but fixed costs are high
What will affect how fixed are variable costs are treated?
depends on costs involved and the likely demand and selling price of the product
How are goods sold by a business usually valued?
set at a price in comparison with other manufacturers of the same or similar products (unless they produce a unique good with sole manufacturing rights)
What will happen in a free economy with buyers? (price market will bear)
Will purchase form the supplier that can produce the product at least cost
What would happen to inefficient producers in an ideal world?
will be forced out of the market and in order to re-establish themselves will have to look closely at their costings and/or production techniques.
What is the problem with breakeven analysis?
assumes that the relationship between sales revenue, variable costs and fixed costs remains the same at all levels of production (simplistic view)
What ae the limitations of break even graphs (and break even calculations)?
All cost and revenue expressed as straight lines
Fixed costs do not remain fixed at all levels of production
Not possible to extrapolate the graph
Profit or loss shown by the graph or calculations is probably only true for figures close to current production levels
Concentrates too much attention on break-even point
Difficult to use in a multi product firm
Based on estimates not always accurate
Only takes into account financial factors
Why is all cost and revenue being expressed in terms of straight lines a limitation of break-even analysis?
Not always the case
Selling price may vary at different quantities
variable costs alter at different levels as a business takes of lower prices gained from bulk buying or more efficient production methods
What is an example of fixed costs not remaining at all levels of production? (limitation of break even analysis)
a decision to double production is likely to increase the fixed costs
What does it mean when you say the break even graph can’t be extrapolated?
Means that the lines on the graph can’t be extended beyond the beyond limit of activity the graph is based on
Why is the time relation of the break even graph a limitation?
As the further away from current figures you go the less accurate the profit or loss shown will be
Why is sensitivity analysis used?
To evaluate the effects and changes in sales volume, selling price and costs on the break even point and profits
What is needed for sensitivity analysis?
Variable and fixed production costs must be known
What can sensitivity analysis be used to consider?
A fall in sales
A fall in price
A rise is variable cost
A rise in fixed costs
How can sensitivity analyse a fall in sales?
How much sales would have to fall to break even
Expressed as a % (usual % change calculation)
How can sensitivity analysis consider a fall in price?
How much price would need to fall for business to break even
Work out contribution per unit at breakeven differnce between (selling price - variable cost) and breakeven contribution is the fall
Can be presented as %
How does sensitivity analysis consider a rise in variable cost?
How much the variable costs have to rise for business to breakeven
Opposite of selling price to meet contribution for breakeven you increase the variable cost
Shown as % increase
How can sensitivity analysis consider a rise in fixed cost?
How much fixed costs would have to rise to breakeven
Would increase fixed cost by however mush profit there is
Can be shown as %
What are uses of break even graphs?
Easy to understand and read
Good way to present information to non-financial people
Good way to see how different changes impact the business
Predict profit/loss at different output levels
Business start-up can see if business if worth setting up
