Chapter 7: Short Term Decision Making

Question 1

Define the break even point and how to calculate it in terms of units and revenue.

Answer 1

The break even point is the volume of sales where neither a profit or loss is made.

Break even point (units) = fixed costs/contribution per unit

Break even point (revenue) = fixed costs/contribution per unit x selling price per unit

Question 2

Define the margin of safety and how to calculate it in terms of units, percentage and revenue.

Answer 2

The Margin of Safety is a measure of how much a business can afford its sales to drop before it stops making a profit and starts losing money. It is also known as a buffer.

Margin of safety (units) = budgeted sales units - break even sales units

Margin of safety (%) = (budgeted sales units - break even sales units)/budgeted sales units x 100

Margin of safety (revenue) = margin of safety (units) x selling price per unit

Question 3

How do you calculate sales volume to achieve a particular profit?

Answer 3

(Fixed costs + required profit)/contribution

Question 4

How do you calculate sales value to achieve a particular profit?

Answer 4

(Fixed costs + required profit)/contribution x sales price per unit

Question 5

What are the three steps to calculate the required contribution per unit?

Answer 5

1. (Fixed costs + required profit)/sales volume
2. Calculate the increase in contribution
3. Add the increase to the orignal sales price

Question 6

Define the P/V (profit/volume) ratio and the two ways the calculate it.

Answer 6

The P/V ratio tells you how much of each pound of sales is available to cover overheads and generate profit, making it a key indicator of profitability.

P/V ratio = contribution per unit/selling price per unit

P/V ratio = total contribution/total revenue

Question 7

How can the P/V ratio be used in the break even and target profit calculations?

Answer 7

The decimal format of the P/V ratio can replace contribution per unit