Topic 7 - Breakeven and Limiting Factor Analysis Flashcards
Breakeven analysis definition
Breakeven analysis or cost-volume-profit (CVP) analysis is the study of the interrelationships between costs, volume and profit at various levels of activity
Breakeven point (BEP) definition
The breakeven point (BEP) is the number of units sold in order for the business to break even.
Breakeven point (BEP) formula - 3 methods
The breakeven point (BEP) is the number of units sold in order for the business to
Breakeven point (BEP)
= Number of units of sale required to break even
= Contribution required to breakeven / Contribution per unit
= Total fixed costs / Contribution per unit
Contribution ratio definition
The contribution ratio is a measure of how much contribution is earned from each £1 of sales revenue.
Contribution ratio = (Contribution per unit / Sales price per unit) √ó 100%
It can be used to calculate the breakeven revenue.
Contribution ratio formula
The contribution ratio is a measure of how much contribution is earned from each £1 of sales revenue.
Contribution ratio = (Contribution per unit / Sales price per unit) √ó 100%
It can be used to calculate the breakeven revenue.
Breakeven revenue definition
Breakeven revenue is the revenue earned by a business in order for it to break even.
Breakeven revenue formula - 2 methods
Breakeven revenue is the revenue earned by a business in order for it to break even.
Breakeven revenue
= Contribution required to break even / Contribution ratio
= Fixed costs / Contribution ratio
Margin of safety definition
The margin of safety is the amount by which sales can fall below budgeted sales without a loss being incurred.
Margin of safety formula - 2 methods
The margin of safety is the amount by which sales can fall below budgeted sales without a loss being incurred.
Margin of safety = Budgeted sales – Breakeven sales
or
Margin of safety = (Budgeted sales – Breakeven sales) / Budgeted sales × 100%
Sales volume to achieve target profit formula. CVP (cost-volume-profit)
CVP analysis and profit targets.
The breakeven formula can be amended to calculate the sales volume required to achieve a target profit.
Sales volume to achieve target profit = (Fixed costs + Required profit) / Contribution per unit
What is a breakeven chart?
A chart that indicates the profit or loss at different levels of sales volume within a limited range.
What are the key lines drawn on a breakeven chart? 3
- Sales line
- Fixed costs line
- Total costs line
Where is the breakeven point (BEP) on a breakeven chart?
The intersection of the sales line and the total costs line.
What does the distance between the BEP and expected (budgeted) sales indicate?
The margin of safety at that level of sales.
What is the main issue with a traditional breakeven chart?
It does not allow direct reading of contribution from the chart.
Limitations of breakeven or CVP analysis and breakeven charts 5
- Scales
- Not complex enough - graphs too simple as businesses make more than 1 product
- Assuming sales = production but could also be some left over inventory
- Assuming variable costs will always be constant
- Assign all costs and sales are straight lines
How does a contribution breakeven chart differ from a traditional breakeven chart?
It draws the variable cost line instead of the fixed cost line to allow direct reading of contribution.
What are the advantages of CVP analysis and breakeven charts? 2
- Provides simple and quick estimates.
- Graphically represents breakeven arithmetic.
Multiple Choice: What is the function of a breakeven chart?
A) To show total revenue only
B) To indicate the profit or loss at different sales levels
C) To calculate tax liabilities
D) To predict future stock market prices
Correct Answer: B) To indicate the profit or loss at different sales levels.
Multiple Choice: How does a contribution breakeven chart improve traditional breakeven analysis?
A) By removing the total cost line
B) By drawing the variable cost line instead of the fixed cost line
C) By eliminating the need for breakeven calculations
D) By including only revenue data
Correct Answer: B) By drawing the variable cost line instead of the fixed cost line.
What is a limiting factor or key factor?
‘Anything which limits the activity of an entity’.
What could be considered a limiting factor?
Sales if there is a limit to sales demand, or any organisational resource (e.g., labour, materials) that is insufficient to meet production demands.
How should a business rank its products in a limiting factor situation?
Products should be ranked in terms of contribution per unit of scarce resource to maximise contribution.
Why might an organisation not be able to produce the profit-maximising product mix?
Because the mix and/or volume of products that can be produced and sold may be restricted by a factor other than a scarce resource.
What should an organisation consider if it has to produce a minimum number of a particular product?
The products should be ranked normally, but the production plan must first account for the minimum production requirements. Then the optimum production plan.
Multiple Choice: How should products be ranked in a limiting factor situation?
A) Based on their total revenue
B) Based on their contribution per unit of scarce resource
C) Based on customer preferences only
D) Based on the number of units produced
Correct Answer: B) Based on their contribution per unit of scarce resource.
Multiple Choice: What is an example of a limiting factor?
A) Unlimited access to materials
B) A shortage of skilled labour
C) Excessive production capacity
D) Surplus stock in inventory
Correct Answer: B) A shortage of skilled labour.
Name four limiting factors 4
- Scarce resources
- Lack of storage
- Complementary products - can’t have one without the other
- Legislation e.g. can only sell x number of a product
What is an alternative approach to overcome a limiting factor?
An organisation may subcontract some of the work to do more and increase profitability.
When should a company subcontract work?
When it needs to make up a shortfall in its own in-house capabilities.
How can total costs be minimised when subcontracting?
By ensuring that the bought units have the lowest extra variable cost of buying per unit of scarce resource saved by buying.
Why might profits not always be maximised in limiting factor situations?
Because the company may need to fulfill important orders first or produce a full complementary product line.
Multiple Choice: When should a company consider subcontracting?
A) When it has unlimited production capacity
B) When it needs to make up for a shortfall in in-house capabilities
C) When it wants to completely outsource all operations
D) When it has no limiting factors
Correct Answer: B) When it needs to make up for a shortfall in in-house capabilities.
Multiple Choice: How can a company minimise total costs when subcontracting?
A) By selecting units with the highest extra variable cost
B) By purchasing units with the lowest extra variable cost per unit of scarce resource saved
C) By ignoring cost factors altogether
D) By subcontracting all work regardless of cost
Correct Answer: B) By purchasing units with the lowest extra variable cost per unit of scarce resource saved.
