Break even analysis Flashcards
What does a break-even analysis do?
determines level of sales needed in order to cover all the costs associated with the output
What is a break-even analysis used for?
commonly used tool by start-ups and firms to decide on whether to invest in certain projects or products
What is break-even quantity?
level of output necessary so a business doesn’t make a profit or a loss
How do you calculate break-even quantity?
fixed costs/ (selling price - avg variable cost)
or
fixed costs/contribution per unit
Where is the break even point?
where the total revenue line intersects the total cost line
How can you know on a BE chart if the firm will lose or gain?
to the left of BEQ - loss
to the right of BEQ - profit
Formula for calculation contribution
Price - AVC
What is the unit contribution?
difference between a firm’s selling price and its average variable cost
represents the amount of money earned from each unit sold
What is the safety margin?
numerical difference between how much the business sells and its break even quantity
What is the target profit output?
quantity of sales required to reach the firm’s target profit
What is the formula for target profit quantity?
(fixed cost + target profit) / (price - average variable cost)
What is target profit?
the amount of profit that a firm aims to earn within a given time period
What is the target price?
the amount customers need to pay per unit in order for the firm to break even or to reach a target profit
Formulas for target price to break even
target price = average fixed cost + average variable cost
target price = (total fixed cost/output) + average variable cost
Formula for target price beyond break even
target price = (target profit + total cost)/quantity of output
What is the effect of increasing the selling price on the break even chart?
- greater gradient of TR line
- reduces break-even quantity
- raises margin of safety (assuming sales volume does not fall)
What is the effect of higher production costs on the break even chart?
- total cost line would be steeper if variable costs increase or shifted upwards if fixed cost increase
- increases break-even quantity
- decreases margin of safety
What are the limitations of break even analysis?
- prices assumed to be constant - discounts/bulk buying not taken into consideration
- costs assumed to be constant (eg economies of scale not considered)
- external changes
- difficult for many products/services
- any inaccuracies/deliberate bias invalidate results
- no qualitative considerations
