Theme 2- managing business activities Flashcards
What is the formula for contribution per unit?
Selling price per unit - variable cost per unit
What is the formula for total contribution?
Contribution per unit x quantity sold
What is the definition of contribution?
The difference between the variable cost per unit and selling price per unit
What is break-even?
It compares a firms revenue with its fixed and variable costs to identify the minimum level of sales needed to cover costs
What is the break-even point?
When total fixed costs + total variable costs = total revenue
What is the formula for the break-even output?
Fixed costs / selling price per unit - variable cost per unit
fixed costs / contribution per unit
What is the formula needed to use contribution in order to find profit?
Total contribution - fixed costs = profit
How can one increase the total contribution?
Either sell more units or boost contribution per unit by increasing prices or cutting variable costs
What is a break-even chart?
It is a graph showing the revenue and costs for a business at all possible levels of output. The horizontal axis represents costs for the business and the vertical axis represents costs and sales in pounds.
What is the margin of safety?
The amount by which demand can fall before the firm starts making losses, it is the difference between the actual and the break-even point
How do you calculate the margin of safety?
Sales - break-even point
What are the effects of a price rise on a break-even chart?
- it’s revenue line will rise more steeply than before
- it will lower the break-even output
- it will increase the profit potential at each level of output
What is the effect of a rise in variable costs on a break-even chart?
- the variable costs line rise more steeply and this will affect the total costs and so will the break-even profit, you will have to sell more to achieve the break-even output
What are the advantages of break-even analysis?
- estimate the future level of output they will need to produce and sell in order to meet given profit objectives
- it’s easy and quick to do, managers can see the break-even output and margin of safety immediately so they can take quick actions to cut costs or increase sales if they need to increase their margin of safety
- business can use break-even analysis to help persuade the bank to give them a loan
What are the limitations of break-even analysis?
- the model is too simple. It assumes that variable costs increase constantly, which ignores the benefits of economies of scale
- it assumes that all output is sold, in times of low demand, a firm may have difficulty in selling all that it produces
- break-even analysis assumes that the firm sells all of its output at a single price
What is the purpose of budgets?
- to ensure that no department or individual spends more than the company expects, preventing unpleasant surprises
- to provide a yardstick against which a manager’s success or failure can be measured
- the motivate the staff in a department, budget figures can be used for assessing staff performance, then staff know what they must achieve
What is budgeting?
It is the process of setting targets, covering all aspects of costs and revenues. It is a method for turning a firm’s strategy into reality.
What is a budgeting system?
It shows how much can be spent over a time period and gives managers a way to check whether they are in track.
How do you construct a budget?
- make a judgement of the likely sales revenue for the coming year
- set a cost ceiling that allows for an acceptable level of profit
- budget for the whole company’s costs to then be broken down into each division, this can be then broken down further for each manager
What are the three types of budgeting?
1) revenue budget- sets out expected sales revenue from selling products, includes levels of sales, a start-up would have a lower revenue
2) profit budget- combining revenue and expenditure budgets to get profit/loss, new business only have a profit later
3) expenditure budget- also known as cost/production budget, sets out expected expenditure on monthly basis, plan of costs required for operation of business
What are the two methods for budgeting?
Historical budget
Zero-based budget
What is a historical budget and what are the pros and cons?
This is treating last year’s budget figures as the main determinant of this year’s budget. Minor adjustments will be made for inflation or other foreseeable changes.
Pros: it is quicker, increased efficiency
Cons: may not be very accurate, cannot predict economic changes and so can be risky
What is a zero-based budget and what are the pros and cons?
This sets departments budget as zero and works it way up, it demands that budget holders, in setting their budget, justify every pound they ask for. This helps to common phenomenon of budgets creeping upwards each year.
pros:
- encourages improvement to the business, each department are able to innovate and improve productivity through investing
cons:
- the only serious drawback is that it takes a long time to find good reasons to justify why you need a budget if £150,000 instead of £100,000
- because it is so time-consuming, it is sensible to use it every few years, rather than every year
What is the best criteria for setting budgets?
- relate the budget directly to the business objective, if a business wants to increase sales and market share then the best method may be to increase the advertising budget
- to involve as many people as possible in the process, people will be more committed to reaching the targets