Break even analysis

Question 1

What does a break-even analysis do?

Answer 1

determines level of sales needed in order to cover all the costs associated with the output

Question 2

What is a break-even analysis used for?

Answer 2

commonly used tool by start-ups and firms to decide on whether to invest in certain projects or products

Question 3

What is break-even quantity?

Answer 3

level of output necessary so a business doesn’t make a profit or a loss

Question 4

How do you calculate break-even quantity?

Answer 4

fixed costs/ (selling price - avg variable cost)

or

fixed costs/contribution per unit

Question 5

Where is the break even point?

Answer 5

where the total revenue line intersects the total cost line

Question 6

How can you know on a BE chart if the firm will lose or gain?

Answer 6

to the left of BEQ - loss
to the right of BEQ - profit

Question 7

Formula for calculation contribution

Answer 7

Price - AVC

Question 8

What is the unit contribution?

Answer 8

difference between a firm’s selling price and its average variable cost
represents the amount of money earned from each unit sold

Question 9

What is the safety margin?

Answer 9

numerical difference between how much the business sells and its break even quantity

Question 10

What is the target profit output?

Answer 10

quantity of sales required to reach the firm’s target profit

Question 11

What is the formula for target profit quantity?

Answer 11

(fixed cost + target profit) / (price - average variable cost)

Question 12

What is target profit?

Answer 12

the amount of profit that a firm aims to earn within a given time period

Question 13

What is the target price?

Answer 13

the amount customers need to pay per unit in order for the firm to break even or to reach a target profit

Question 14

Formulas for target price to break even

Answer 14

target price = average fixed cost + average variable cost

target price = (total fixed cost/output) + average variable cost

Question 15

Formula for target price beyond break even

Answer 15

target price = (target profit + total cost)/quantity of output

Question 16

What is the effect of increasing the selling price on the break even chart?

Answer 16

• greater gradient of TR line
• reduces break-even quantity
• raises margin of safety (assuming sales volume does not fall)

Question 17

What is the effect of higher production costs on the break even chart?

Answer 17

• 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

Question 18

What are the limitations of break even analysis?

Answer 18

• 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