Topic 7 - Breakeven and Limiting Factor Analysis

Question 1

Breakeven analysis definition

Answer 1

Breakeven analysis or cost-volume-profit (CVP) analysis is the study of the interrelationships between costs, volume and profit at various levels of activity

Question 2

Breakeven point (BEP) definition

Answer 2

The breakeven point (BEP) is the number of units sold in order for the business to break even.

Question 3

Breakeven point (BEP) formula - 3 methods

Answer 3

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

Question 4

Contribution ratio definition

Answer 4

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.

Question 5

Contribution ratio formula

Answer 5

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.

Question 6

Breakeven revenue definition

Answer 6

Breakeven revenue is the revenue earned by a business in order for it to break even.

Question 7

Breakeven revenue formula - 2 methods

Answer 7

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

Question 8

Margin of safety definition

Answer 8

The margin of safety is the amount by which sales can fall below budgeted sales without a loss being incurred.

Question 9

Margin of safety formula - 2 methods

Answer 9

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%

Question 10

Sales volume to achieve target profit formula. CVP (cost-volume-profit)

Answer 10

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

Question 11

What is a breakeven chart?

Answer 11

A chart that indicates the profit or loss at different levels of sales volume within a limited range.

Question 12

What are the key lines drawn on a breakeven chart? 3

Answer 12

1. Sales line
2. Fixed costs line
3. Total costs line

Question 13

Where is the breakeven point (BEP) on a breakeven chart?

Answer 13

The intersection of the sales line and the total costs line.

Question 14

What does the distance between the BEP and expected (budgeted) sales indicate?

Answer 14

The margin of safety at that level of sales.

Question 15

What is the main issue with a traditional breakeven chart?

Answer 15

It does not allow direct reading of contribution from the chart.

Question 16

Limitations of breakeven or CVP analysis and breakeven charts 5

Answer 16

• 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

Question 17

How does a contribution breakeven chart differ from a traditional breakeven chart?

Answer 17

It draws the variable cost line instead of the fixed cost line to allow direct reading of contribution.

Question 18

What are the advantages of CVP analysis and breakeven charts? 2

Answer 18

1. Provides simple and quick estimates.
2. Graphically represents breakeven arithmetic.

Question 19

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

Answer 19

Correct Answer: B) To indicate the profit or loss at different sales levels.

Question 20

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

Answer 20

Correct Answer: B) By drawing the variable cost line instead of the fixed cost line.

Question 21

What is a limiting factor or key factor?

Answer 21

‘Anything which limits the activity of an entity’.

Question 22

What could be considered a limiting factor?

Answer 22

Sales if there is a limit to sales demand, or any organisational resource (e.g., labour, materials) that is insufficient to meet production demands.

Question 23

How should a business rank its products in a limiting factor situation?

Answer 23

Products should be ranked in terms of contribution per unit of scarce resource to maximise contribution.

Question 24

Why might an organisation not be able to produce the profit-maximising product mix?

Answer 24

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.

Question 25

What should an organisation consider if it has to produce a minimum number of a particular product?

Answer 25

The products should be ranked normally, but the production plan must first account for the minimum production requirements. Then the optimum production plan.

Question 26

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

Answer 26

Correct Answer: B) Based on their contribution per unit of scarce resource.

Question 27

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

Answer 27

Correct Answer: B) A shortage of skilled labour.

Question 28

Name four limiting factors 4

Answer 28

* 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

Question 29

What is an alternative approach to overcome a limiting factor?

Answer 29

An organisation may subcontract some of the work to do more and increase profitability.

Question 30

When should a company subcontract work?

Answer 30

When it needs to make up a shortfall in its own in-house capabilities.

Question 31

How can total costs be minimised when subcontracting?

Answer 31

By ensuring that the bought units have the lowest extra variable cost of buying per unit of scarce resource saved by buying.

Question 32

Why might profits not always be maximised in limiting factor situations?

Answer 32

Because the company may need to fulfill important orders first or produce a full complementary product line.

Question 33

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

Answer 33

Correct Answer: B) When it needs to make up for a shortfall in in-house capabilities.

Question 34

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

Answer 34

Correct Answer: B) By purchasing units with the lowest extra variable cost per unit of scarce resource saved.