Business 5.5

Question 1

What is contribution

Answer 1

Contribution refers to the sum of money that remains after all direct or variable costs have been taken away from the sales revenue of a product.

Question 2

What is contribution per unit

Answer 2

Contribution per unit (or unit contribution) is the difference between the selling price of a product and its variable costs of production. The surplus goes towards paying fixed costs.
Contribution per unit = P - AVC

Question 3

What is total contribution

Answer 3

Total contribution is the gross profit earned on the sales of the product.

Total contribution = (P - AVC) * Q or TR - TVC

Question 4

What is profit in terms of contributiion

Answer 4

Profit is the positive difference between a firm’s total revenue and its total costs.

Profit = total contribution - total fixed costs

    `= [(P - AVC) * Q] - TFC`

Question 5

What is break even analysis

Answer 5

is a decision-making quantitative tool that allows business owners to forecast a level of production in any given price in order to cover all costs.

Question 6

Carrying out a break-even analysis can inform managers of two important things:

Answer 6

Carrying out a break-even analysis can inform managers of two important things:

• Whether it is financially worthwhile to produce or launch a particular good or service
• The expected level of profits that the business will earn if things go according to plan.

But may also use it:

• To support an application for a loan from a bank or other financial institution
• To assess the impact of changes in the level of production on the profitability of the business
• To assess the effects of different prices and levels of costs on the potential profitability of the business
• To model changes to fixed and variable costs

Question 7

what is break even quantity

Answer 7

Break-even quantity, also known at break-even output, is the level of sales required for a business to reach break-even.

Question 8

what is break even point

Answer 8

• Break-even point is the point on a break-even chart where firm’s total costs equal to its total revenue, shown by the intersection of the TR and TC curves.BEP or BE = FC ÷ Contribution Per Unit

Question 9

Total contribution and profit (talk about loss break even and profit in relation with Tr and TC

Answer 9

Profit/loss = Total Contribution - FC

Financial situations a business can be in:

• Loss: when TC > TR
• Break-even: when TC = TRP * Q = TFC + TVC
• Profit: TR > TC

Question 10

WHat is the break even chart

Answer 10

Break-even chart is a diagrammatic representation of how total costs and total revenues change with increasing levels of production or sales. It shows a firm’s costs, revenues and profits (or loss) at various levels of output.

• The output at which this occurs is called the BEQ.

Question 11

What is the margin of safety

Answer 11

Margin of safety, also known as the safety margin, this refers to the numerical difference between a firm’s volume of sales and its break-even quantity.

MOS = Current level of sales - BEQ

MOS (as %) = [(Current level of sales - BEQ) ÷ Current level of sales] * 100

Question 12

What does margin of safety imply

Answer 12

• It indicates the degree of risk.
• High/Big MoS → Sales fall significantly and may still break-even
• Low/Big MoS → Sales fall relatively little and will make a loss (riskier than High Mos)

Question 13

What is target profit output

Answer 13

Target profit output, also known as the target profit quantity, refers to the quantity of sales required to reach the firm’s target profit.

TPO = (FC + target profit) ÷ contribution per unit

Question 14

WHat is target profit

Answer 14

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

Question 15

What is target price

Answer 15

Target price is the price set by a firm in order to reach break- even or a certain target profit.

Question 16

Increase in price effect on BEC

Answer 16

Effect on chart: Total revenue pivots upwards
Effect on contribution per unit: Increases
Impact of profit margin: Increases
Effect on break-even quantity: Falls
Effect on margin of safety if sales stay the same: Increases
Effect on profit: Depends on effect on sales, e.g., how much they fall. If they do not fall much, profit may rise.

Question 17

Decrease in price effect on BEC

Answer 17

Effect on chart: Total revenue pivots downwards
Effect on contribution per unit: Decreases
Impact of profit margin: Decreases
Effect on break-even quantity: Rises
Effect on margin of safety if sales stay the same: Decreases
Effect on profit: Depends on effect on sales, e.g., how much they rise; if they rise enough profit may rise.

Question 18

Increase in fixed costs effect on BEC

Answer 18

Effect on chart: Total costs shifts upwards
Effect on contribution per unit: No change
Impact of profit margin: Gross margin not affected but operating profit will fall
Effect on break-even quantity: Rises
Effect on margin of safety if sales stay the same: Decreases
Effect on profit: Reduces if sales do not change.

Question 19

Decrease in fixed costs effect on BEC

Answer 19

Effect on chart: Total costs shifts downwards
Effect on contribution per unit: No change
Impact of profit margin: Gross margin not affected but operating profit will rise
Effect on break-even quantity: Falls
Effect on margin of safety if sales stay the same: Increases
Effect on profit: Increases if sales do not change.

Question 20

Increase in variable cost per unit effect on BEC

Answer 20

Effect on chart: Total costs pivots upwards
Effect on contribution per unit: Decreases
Impact of profit margin: Decreases
Effect on break-even quantity: Rises
Effect on margin of safety if sales stay the same: Decreases
Effect on profit: Reduces if sales do not change.

Question 21

Decrease in variable cost per unit effect on BEC

Answer 21

Effect on chart: Total costs pivots downwards
Effect on contribution per unit: Increases
Impact of profit margin: Increases
Effect on break-even quantity: Falls
Effect on margin of safety if sales stay the same: Increases
Effect on profit: Increases if sales do not change.

Question 22

Advantage of break-even analysis as a decision-making tool

Answer 22

Certainly! Here’s the text from the image:

Advantages

Simple technique: Expensive training is not needed and is suitable for new/small businesses.

Immediate results: It is a technique that can be completed quickly.

Financing: Be of value in supporting a business’s bank loan application so external stakeholders can determine the level of risk involved.

Strategy changes: A business can examine several different cost and revenue scenarios in order to consider strategy changes that might increase revenues or decrease costs.

Allows forecast: The effect of varying numbers of customers on its costs, revenues and profits.

Analyse profitability: For a business to assess whether its idea will earn a profit.

Question 23

Limitation of break-even analysis as a decision-making tool

Answer 23

Assumptions made: The tool assumes all products are sold.

Simplification of the real world: It is difficult to use when businesses sell different products at different prices so the average would not be accurate.

Costs and revenues are not linear. Break-even analysis assumes costs and revenues are linear, but in reality, they are not.

Time-consuming for large product portfolios: Separate break-even analyses must be done for each product.

Changing assumptions: Costs and revenues will change, so businesses need to regularly update assumptions for break-even analysis.

Forecasts could be wrong if costs or selling price are incorrect.