Break even analysis - 3.3

Question 1

Break even

Answer 1

The level of output at which total costs equal total revenue

Question 2

What is the equation for total contribution?

Answer 2

Total revenue – Total variable cost

Question 3

What is the equation for contribution per unit?

Answer 3

Price per unit – Variable cost per unit

Question 4

Where is the break even point on a break even chart?

Answer 4

Intersection of Total Cost and Total Revenue

Question 5

What does the margin of safety show?

Answer 5

Shows how much demand exceeds or fails to exceed BEQ

Question 6

What is the equation for margin of safety?

Answer 6

Sales volume (Projected Demand) – BEQ

Question 7

Title of break even chart

Answer 7

Break Even Analysis for Company XYZ

Question 8

Label axes

Answer 8

X-axis is output

Y-axis is Revenue/Cost (label currency as well)

Question 9

Draw Total Revenue line

Answer 9

Starts at (0,0), intersects BEP

Question 10

Draw Total Cost line

Answer 10

Starts at TFC at x=0, intersects the BEP

Question 11

Limitations of BE

Answer 11

Makes several assumptions:

Fixed costs must be paid regardless of output

Variable cost increases linearly

Ignores economies of scale

Sales revenue increases linearly

Ignores discounts for large orders and price discrimination

Assumes only one product is sold

Every unit of output is sold

Selling price is constant regardless of units sold

Provides a static model (e.g. production costs can change)

Depends on reliability of data

Other factors can have an effect (e.g. competitors, staff motivation)

Only suitable for single product firms

Question 12

What does the break even help to find?

Answer 12

Helps to tell whether a good can be financially worthwhile and the level of profit a business is likely to earn

Question 13

What does the BE find?

Answer 13

Can be used to calculate level of sales needed to attain a certain profit

Question 14

What does the BE ignore when calculating level of sales needed to attain a certain profit?

Answer 14

Ignores other factors that affect profit:

Different pricing throughout time
Level of demand is subject to change
Profit depends on risk
Innovation and luck – prediction aren’t always followed

Question 15

What does the BE have to consider when calculating level of sales needed to attain a certain profit?

Answer 15

Pricing strategies (penetration pricing, market skimming, etc.)

Price elasticity