Chapter 19: Break-even analysis + EOS, DEOS

Question 1

What are the 2 types of costs

Answer 1

Fixed
Variable

Question 2

Explain what fixed costs are
give 2 examples
another name

Answer 2

Costs that do not vary in the short term with the scale of production of the firm.

eg: rent, salaries, etc.

aka: overhead costs.

Question 3

Explain variable costs
2 examples

Answer 3

Costs that vary directly with respect to the scale of production

eg: wages, raw materials costs, etc.

Question 4

total cost formula

Answer 4

Total cost = Fixed costs + Variable costs

Question 5

average cost formula
aka

Answer 5

Average cost = Total cost/output
aka unit costs

Question 6

How can cost data be used

Answer 6

Setting prices - Cost plus pricing. If avg cost = 5 usd, and you wanna make a profit of 1 usd per unit then set price at 6 usd etc .

Deciding to stop or cont production - When costs > revenue then business may decide to stop production, or cut down costs, etc.

Question 7

What are economies of scale

Answer 7

Factors that lead to a reduction in average costs as a busines increases in size.

Question 8

What are the 5 economies of scale

Answer 8

Purchasing
Marketing
Financial
Managerial
Technical

Question 9

What are Financial EOS

Answer 9

Larger companies can borrow more money from banks at a lower rate of interest, hence its cheaper for them to borrow.

This is becuase they can put up more assets as collateral.

Question 10

What are Managerial EOS

Answer 10

Larger companies can afford specialists and this increases their efficiency and helps to reduce their average costs.

Question 11

What are Purchasing EOS

Answer 11

They are able to buy raw materials etc in bulk which they usually get discounts on. This reduces the total cost, hence reducing the average cost.

Question 12

What are marketing EOS

Answer 12

Advertising costs do not go up in the same proportion as the size of an advertisement ordered by the business.

Larger businesses may order for bigger advertisements that could be more cost effective.

Question 13

What are Technical EOS

what is flow production

Answer 13

The use of flow production and the latest equipment will reduce the average costs for the large manufacturing businesses

flow production = division of labour and specialization
small business usually can’t afford

Question 14

Definition of Diseconomies of Scale

Answer 14

Factors that lead to an increase in average costs as a business grows beyond a certain size.

Question 15

Name the DEOS

Answer 15

Poor communication
Lack of commitment from employees
demotivation
Weak coordination

Question 16

Explain Poor communication DEOS

Answer 16

Becomes increasingly difficult to send and receive accurate messages across larger firms. This leads to slower and less accurate messages that can lead to inefficacy or mistakes.

Question 17

Explain lack of commitment from employees/demotivation DEOS

also explain the “opposing” point

Answer 17

As organisations get larger and larger, employees may feel like they’re not valued in the firm and may not be able to get in contact with the top management in the firm. This would demotivate and lead to a lack of commitment of the workers them which could lead a reduction in output.

Furthermore if the employees are demotivated and there is a lack of commitment, the turnover rate of employees could be high. This means that they would be constantly leaving and the firm would have to invest valuable time and resources to replace the employees which could lead to a higher avg cost.

On the contrary - if the firm is bigger and the chain of command is bigger then there are more positions for promotion that could also motivate the employees to work harder and move up in the firm.

Question 18

Explain weak coordination DEOS

Answer 18

Takes time for decisions taken by managers to reach all the different employees and departments. Makes it hard to coordinate between departments so that they are all working towards the same objective

Employees could also take a long time to react to a managerial decision once it has been taken

Question 19

Definition of the break-even level of output

Answer 19

is the quantity that must be produced/sold for total revenue to equal total costs

Question 20

Revenue definition and formula

Answer 20

Income during a period of time from the sale of goods or services.

Revenue = Price per unit * Number of units sold

Question 21

What are break-even charts and what do they show

Answer 21

Graphs that show how the costs and revenue of a business change with sales and the level of sales the business must make in order to break even

Question 22

What is the break-even point

Answer 22

The level of sales at which TC (total costs) = TR (total revenue)

Question 23

What are the advantages of a break-even chart

Answer 23

Managers can tell the expected profit or loss at any level of output.

Graph can be redrawn with different variables to show how the profit and loss is impacted. eg: changing the price at which the good is sold and then redrawing

Helps show the margin of safety

Question 24

What is the margin of safety
why is it important

Answer 24

Amount by which sales exceeds the breakeven point.

its important because the manger knows by how much the sales can fall so that they still make a profit.

Question 25

Limitations of the break-even chart

Answer 25

Assumes that all goods produced are sold, which may not be true

The break-even chart only focuses on the break-even point and neglects the other important aspects of the business. eg: how to reduce waste/increase sales etc.

Assumes that costs and revenues always increase proportionally (in a straight line), but in reality the both the costs and revenue could be curves. Eg: economies/diseconomies or scales (impacts the cost curve) or offering discounts on large orders (impacts the revenue curve).

Question 26

What is the contribution of each unit

Answer 26

Contribution of a product = selling price - variable costs.

Question 27

Contribution formula for break-even level of production

Answer 27

Break-even level of production = Total fixed costs/contribution per unit