Break even analysis

Question 1

What is breaking even?

Answer 1

This is when a business is able to cover their costs.

Question 2

What is the Break even point (BE output)?

Answer 2

The level of sales a business needs to cover it’s total costs, at the break even point, a businesses total FC and VCs should = total revenue, essentially meaning they are making £0 profit but no loss either.

Question 3

What happens when sales are below the BE point?

Answer 3

Costs are more than revenue; the business makes a loss.

Question 4

What happens when sales are above the BE point?

Answer 4

Revenue exceeds costs - the business makes a profit.

Question 5

What is a BE analysis?

Answer 5

This is analysis which finds a businesses break even point. It tells them how much they will need to sell in order to break even - also key for deciding whether to loan to a business; they will want to see a BE analysis to understand how and when they are likely to see returns.

Question 6

Who may use BE analysis?

Answer 6

Established businesses preparing to launch new products use BE analysis to work out how much profit they are likely to make, and also predict the impact of new activity on cash flow.

Question 7

What is contribution used for?

Answer 7

To work out the break even point.

Question 8

What is contribution per unit?

Answer 8

This is the difference between the selling price of a product and the variable costs it takes to produce it.

Question 9

What is the formula for contribution per unit?

Answer 9

Contribution per unit = selling price - variable cost per unit

Question 10

What is total contribution?

Answer 10

Total contribution is the contribution (or amount) from all units sold. It is used to pay fixed costs. The amount left over is profit.

Question 11

When is the break even point achieved?

Answer 11

When total contribution = fixed costs

Question 12

How can you calculate break even point?

Answer 12

If you know your contribution per unit and total fixed costs then you can work out the break even point (essentially working out how many you need to sell to get to £0).

Question 13

What is the formula for break even point?

Answer 13

BE point = Total FC/ Contribution per unit.

Question 14

H sets up a business to print T shirts. The FC are £3000 and the VC are £5, the selling price is £25. Work out the break even point.

Answer 14

BE point = Total FC/Contribution per unit.

Contribution per unit = £25-£5 = £20.

So BE = £3000/20 = 150.

He needs to sell 150 t shirts to break even.

Question 15

What should you do in the event that you get a decimal for the BE point?

Answer 15

Round to the nearest whole number as you cannot have a decimal of a unit sold.

Question 16

What do BE charts show?

Answer 16

They show costs and revenue plotted against output. Businesses use them to see how costs and revenue vary with different levels of output.

Question 17

This is a break even chart for Hs business from an earlier flashcard. What is on either axis? What are plotted on the chart? Where is the break even point on the chart?

Answer 17

Output is shown on the horizontal axis and costs and revenue are shown on the vertical axis.
FC, VC and revenue are plotted on the chart.
The BE point is where the revenue line crosses the total costs line - 150 units here.

Question 18

What can you use a break even chart for?

Answer 18

To identify profit or loss that would be made at a specified level of output, you can find the value of total costs and for revenue at your chosen level of output, then subtract the total costs from the revenue. If the answer is negative, then it’s a loss, and if it is positive, then it’s a profit.

Question 19

What will happen if a business changes their VCs or product price?

Answer 19

This will affect the Break even point.

Increasing prices, would make the break even point lower as you make more revenue per product which means you do not need to sell as many to break even. Similarly, increased VC without increasing prices or lowered prices would make the break even point higher.

Question 20

What is the margin of safety?

Answer 20

The amount between actual output and break even.(How much he makes - how much he needs to make to BE.)

Question 21

Formula for margin of safety?

Answer 21

Margin of safety = actual output - break even output.

Question 22

The diagram included shows the MOS for Hs business when his output is 250 shirts.
What will his MOS be? What would it be if his output was 300?

Answer 22

His MOS is 250 (output) - 150 (BE output).
If his output increases to 300, his MOS will be 300-150 = 150.

Question 23

What does knowing the BE output and MOS do for a business?

Answer 23

Allows them to make informed, important decisions involving whether a business needs to lower costs or increase revenue if possible. If his margin of safety is very big he could push prices down to increase market share and still have a sufficient MOS.
The bigger a businesses MOS, the lower the risk of making a loss.

Question 24

What are the advantages of BE analysis?

Answer 24

Easy to do.
- It is quick and managers can see their BE outputs quickly and MOS quickly to take quick action where necessary, important in dynamic markets.
- It allows businesses to forecast how variations in sales will affect costs, revenue and profits and most importantly how variations in their prices and costs will affect the amounts that they are required to sell.
- It can help to influence decisions on whether to sell a product or not. If a business would have to sell an unrealistic amount then they most likely would refrain from making the product.