ch 3: break-even Flashcards
is of vital importance in determining the practical application of cost functions.
Break-even analysis
It is a function of three factors, i.e., sales volume, cost and profit.
Break-even analysis
It aims at classifying the dynamic relationship existing between total cost and sale volume of a company.
Break-even analysis
Break-even analysis is also known as?
“cost-volume-profit analysis”
the operating condition that exists when a company’a sales reach a point equal to all expenses incurred in attaining that level of sales.
Break-even
is a financial tool which helps a company to determine the stage at which the company, or a new service or a product, will be profitable.
Break-even analysis
In other words, it is a financial calculation for determining the number of products or services a company should sell or provide to cover its costs (particularly fixed costs).
Break-even analysis
is a situation where an organisation is neither making money nor losing money, but all the costs have been covered.
Break-even analysis
s useful in studying the relation between the variable cost, fixed cost and revenue.
Break-even analysis
Generally, a company with low fixed costs will have a?
low break-even point of sale
In the diagram above, the line OA represents the?
variation of income at varying levels of production activity (“output”).
OB represents the?
total fixed costs in the business.
As output increases? meaning that?
variable costs are incurred, meaning that total costs (fixed + variable) also increase.
At low levels of output?
Costs are greater than Income.
At the point of intersection, P? hence?
costs are exactly equal to income, and hence neither profit nor loss is made
Components of Break-even Analysis
- Fixed Cost
- Variable Cost
- Contribution Margin
- Contribution Margin Ratio
*
are those business costs that are not directly related to the level of production or output.
Fixed costs
In other words, even if the business has a zero output or high output, the level of these will remain broadly the same.
fixed costs
In the long-term, these can alter, - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.
fixed costs
Rent and rates
(fixed or variable cost?)
fixed costs
Depreciation
(fixed or variable cost?)
fixed costs
Research and development
(fixed or variable cost?)
fixed costs
Marketing costs (non- revenue related)
(fixed or variable cost?)
fixed costs
Administration costs
(fixed or variable cost?)
fixed costs
Utilities
(fixed or variable cost?)
fixed costs
Internet
(fixed or variable cost?)
fixed costs
Water
(fixed or variable cost?)
fixed costs
Electricity
(fixed or variable cost?)
fixed costs
Heating
(fixed or variable cost?)
fixed costs
are those costs which vary directly with the level of output.
Variable costs
They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue- related costs such as commission.
Variable costs
raw materials
(fixed or variable cost?)
Variable costs
direct labour
(fixed or variable cost?)
Variable costs
fuel
(fixed or variable cost?)
Variable costs
revenue-related cost
(fixed or variable cost?)
Variable costs
commission
(fixed or variable cost?)
Variable costs
A distinction is often made between “Direct” and “Indirect”
variable costs.
are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre.
Direct variable costs
Raw materials and the wages those working on the production line are good examples.
Direct variable costs
cannot be directly attributable to production but they do vary with output.
Indirect variable costs
These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.
Indirect variable costs
is a product’s price minus all associated variable costs, resulting in the incremental profit earned for each unit sold.
Contribution margin
The total contribution margin generated by an entity represents the total earnings available to pay for fixed expenses and to generate a profit.
This concept is useful for deciding whether to allow a lower price in special pricing situations.
contribution margin
,If this, at a particular price point, is excessively low or negative, it would be unwise to continue selling a product at that price.
contribution margin
It is also useful for determining the profits that will arise from various sales levels.
contribution margin
This is the difference between a company’s sales and variable expenses, expressed as a percentage.
Contribution Margin Ratio
The total margin generated by an entity represents the total earnings available to pay for fixed expenses and generate a profit.
Contribution Margin Ratio
When used on an individual unit sale, the ratio expresses the proportion of profit generated on that specific sale.
Contribution Margin Ratio
The contribution margin should be relatively high, since it must be sufficient to also cover fixed expenses and administrative overhead. Also, the measure is useful for determining whether to allow a lower price in special pricing situations. If the contribution margin ratio is excessively low or negative, it would be unwise to continue selling a product at that price point, since the company would have considerable difficulty earning a profit over the long term.
Contribution Margin Ratio
Assumptions of Break-even Analysis
- The total costs may be classified into fixed and variable costs. It ignores semi-variable cost.
- The cost and revenue functions remain linear.
- The price of the product is assumed to be constant.
- The volume of sales and volume of production are equal.
- The fixed costs remain constant over the volume under consideration.
- It assumes constant rate of increase in variable cost.
- It assumes constant technology and no improvement in labour efficiency.
dividing the total fixed costs of production by the price per unit less the variable costs to produce the product.
break-even point formula
Since the price per unit minus the variable costs of product is the definition of the contribution margin per unit, simply rephrase the equation by dividing the fixed costs by the contribution margin
break-even point formula
This computes the total number of units that must be sold in order for the company to generate enough revenues to cover all of its expenses.
break-even point formula
Next, this is calculated by multiplying the price of each unit by the answer from the first equation.
break-even formula in sales dollars
This will provide the total dollar amount in sales needed to achieve in order to have zero loss and zero profit. Now, compute the total number of units that need to be sold in order to achieve a certain level profitability without break-even calculator.
First, take the desired dollar amount of profit and divide it by the contribution margin per unit. The computes the number of units needed to sell in order to produce the profit without taking in consideration the fixed costs. Then add back in the break-even point number of units.
Use of Break-even Analysis
✓ It helps to determine remaining/unused capacity of the company once the breakeven is reached. This will help to show the maximum profit on a particular product/service that can be generated.
✓ It helps to determine the impact on profit on changing to automation from manual (a fixed cost replaces a variable cost).
✓ It helps to determine the change in profits if the price of a product is altered.
✓ It helps to determine the amount of losses that could be sustained if there is a sales
downturn.
is very useful for knowing the overall ability of a business to generate a profit.
break-even analysis
In the case of a company whose breakeven point is near to the maximum sales level, this signifies that?
it is nearly impractical for the business to earn a profit even under the best of circumstances. Therefore, it’s the management responsibility to monitor the breakeven point constantly. This monitoring certainly reduces the breakeven point whenever possible.
