Break even analysis

Question 1

Break even

Answer 1

When total costs = total revenue

Question 2

Calculation for break even

Answer 2

fixed costs/selling price - variable costs

Question 3

Contribution

Answer 3

looks at the profit made on individual products – used in calculating how many items in the business need to be sold to cover all business’ costs.

Question 4

Contribution per unit calculation

Answer 4

selling price per unit - Variable cost per unit

Question 5

Total contribution

Answer 5

Total sales - Total variable costs

Question 6

Margin of safety calculation

Answer 6

Actual sales - Break even level of sales

Question 7

Margin of safety

Answer 7

Looks at the number of sales that can be lost before a business makes a loss.

Question 8

Ways to improve margin of safety

Answer 8

• Increase contribution per unit by raising selling prices, reduce variable costs per unit.
• Lower the break even output by lowering fixed costs, turn fixed costs into variable costs.
• Increase actual output – sell more

Question 9

Pros of break-even

Answer 9

Pros: Useful tool for management as can predict
- Break even output
- Estimates profits at different outputs
- Margin of safety
- Change sale price and predict new Break even, margin of safety and profits.
Highlights importance of fixed costs and keeping them low so break even output is less and margin of safety is higher – means less risk for the business.
Data generated can be used for business plans.
Used as a ‘what if’ tool to work out what happens if prices go up or down.

Question 10

Cons of break-even

Answer 10

Based on predicted data and not actual data.
Many unrealistic assumptions one same price used – may use price skimming.
- Assumes have no waste not realistic
- Doesn’t consider refunds.
- Production costs the same – economies of scale as business grows means costs aren’t accurate.
- Suggests only make and sell one product.
Doesn’t take into account discounts if customer buys in bulk – economies of scale