Flashcards in Business Finance Deck (35):
What is break even?
The level of output or production at which a business's sales generate just enough revenue to cover all its costs of production. At the break even point, a business makes neither a loss nor a profit.
Why is break even analysis used in a business? demand they can survive.
•Estimate levels of output they need to produce & sell
•Assess impact of price changes on profit & output needed to break even •Assess how changes in cost impact on profits and break even output •Determine margin of safety
What are fixed costs?
Costs that have to be paid regardless of the level of production and sales. e.g. fixed cost of factory to manufacture trainers £20,000 a month.
What are variable costs?
Costs dependent on production level. If production increases then costs like wages and raw materials increase.
What are the total costs?
The sum of the fixed and variable costs.
What is revenue?
The income that a business receives from selling goods or services. If each pair of trainers sells at £32.50 each and 1,000 pairs are sold, total revenue is £32,500.
What is the break even formula?
break even point= total fixed costs/contribution
On a break even chart, what do you plot on the horizontal (x) axis?
Output (units) e.g. number of CDs, number of lessons etc.
On a break even chart, what do you plot on the vertical (y) axis?
Costs and Revenue (£)
What type of line do you have for fixed costs and why?
Horizontal fixed costs line. It is horizontal because fixed costs don't change with output.
What is the total costs line?
The fixed cost added to the variable cost gives the total cost.
How do you calculate variable costs?
Variable cost per unit x number of units = Total Variable Costs. e.g. The variable cost per unit is £2 and there are 2,000 units = £4,000.
How do you calculate revenue?
Sales Price x Number of Units
Where is the break even point?
Where the total revenue line crosses the total costs line is the break even point (ie costs and revenue are the same). Everything below this point is produced at a loss, and everything above it is produced at a profit.
What happens if total output and sales are greater than break even?
If total output and sales are greater than break even, then revenue is greater than cost so the business makes a profit.
What happens if total output and sales are equal to break even?
If total output and sales are equal to break even, then revenue equals total cost so the business breaks even.
What happens if total output and sales are less than break even?
If total output and sales are less than break even, then revenue is less than total cost and so the business makes a loss.
What is contribution?
Contribution is the difference between sales price and variable costs
How do you calculate contribution? (formula)
Contribution = sales price - variable costs
What is contribution used for?
Used to pay the fixed costs incurred by a firm.
How is contribution calculated for the sale of a single product? (contribution per unit)
contribution per unit = selling price of one unit of output - variable cost of producing that unit (it's this formula that's useful when calculating the break even point)
Why is it useful to find the contribution for the sale of a single product?
Avoids the need to divide up fixed costs between the firm's various products. This assists entrepreneurs in assessing the financial performance of each of their products.
Alternative method to calculate break even...
break even = fixed costs/contribution per unit
How can break even help an entrepreneur to predict profit or loss?
If an entrepreneur believes that he can provide a achieve a certain level of sales they can use a break even chart to read off the expected profit or loss at various levels of output. Provides guidance as to whether it will be profitable or not.
What is the margin of safety?
The amount by which a firm's current level of output exceeds the level of output necessary to break even.
What is the formula for the margin of safety?
Margin of safety = actual sales - break even point
SARAH'S NEW RESTAURANT IS SUCCESSFUL AND ATTRACTS 600 CUSTOMERS EACH MONTH. HER BREAK EVEN POINT IS 400 CUSTOMERS EACH MONTH? WHAT IS THE MARGIN OF SAFETY AND WHAT DOES THIS MEAN?
Her restaurant could lose 200 customers monthly before it began to make a loss.
What is the impact on break even output if there is a rise in variable costs?
A greater output is necessary to break even. A greater revenue is also necessary (more customers/sales) to break even.
What is the impact on break even output if there is a fall in variable costs?
Smaller output required to break even. Smaller number of customers needed to cover costs (less sales).
What is the impact on break even output if there is a rise in fixed costs?
Greater output to break even. Business incurrs higher costs, so more sales needed to cover costs and break even.
What is the impact on break even output if there is a fall in fixed costs?
Smaller output is necessary to break even. Businesses costs are lower which means fewer sales are required to break even.
What is the impact on break even output if there is a rise in selling price?
Lower output required to break even. Each sale provides the business with greater revenue while costs are unaltered. So fewer sales necessary to break even.
What is the impact on break even output if there is fall in selling price?
Higher output required to break even. Each sale earns the business less revenue so more sales will be required to earn sufficient revenue to break even.
Why is it important for a business that operates in an environment which alters frequently to conduct a break even analysis? (what if analysis?) planning and decision making.
It is too simplistic to assume that costs will remain constant or prices in their markets will not alter over a period of time. Using break even analysis for a number of 'what if?' scenarios can increase the value of the technique in the financial