Unit 3.3 : Break-even Analysis Flashcards Preview

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Flashcards in Unit 3.3 : Break-even Analysis Deck (17)
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1
Q

Contribution

A
  1. The sum of money that remains after all direct and variable costs have been taken away from the sales revenue
  2. It is essentially the amount each unit pays towards fixed costs once variable costs have been covered
  3. Contribution analysis can help a business to identify products that are relatively profitable and ones that might need more attention

Contribution per unit = price - average variable costs
Total contribution = (price - average variable costs) * Quantity sold

2
Q

Profit (in terms of contribution)

A

Profit = Total contribution - total fixed costs

3
Q

How to increase profit

A
  1. Increasing sales of the product, which raises the total contribution (gross profit)
  2. Reducing variable costs, perhaps through negotiating better deals with current suppliers or seeking new suppliers that are more competitive
  3. Reducing fixed costs and overheads, perhaps through better financial control or the use of cost and profit centres
4
Q

Uses of contribution analysis

A
  1. Pricing strategy - helps a business to set prices for each of its products to ensure there is positive contribution
  2. Product portfolio management - Can help managers to decide which products should be given higher investment priority
  3. Make-or-buy decisions
  4. Break-even analysis
5
Q

Break-even analysis

A
  1. A business can only survive in the long term if its revenues exceed its costs.
  2. A business can be in 3 different financial situations - loss, break-even, and profit
6
Q

Loss

A

when costs of production exceed the revenues of the business

7
Q

Break-even

A
  1. when the revenues of the business equal the costs of production
  2. neither a profit nor a loss is made
  3. TC = TR
8
Q

Profit

A

when revenues exceed costs of production

9
Q

Breakeven formula

A

Breakeven quantity = fixed costs / contribution per unit

10
Q

Margin of safety

A
  1. Margin of safety measures the difference between a firm’s sales volume and the quantity needed to break-even
  2. quantity sold over and above the breakeven level of output
  3. If there is a positive MOS, the firm is making a profit, whereas a negative safety margin means the firm makes a loss
  4. Margin of safety = level of demand - break-even quantity
11
Q

Target profit level of output

A

(fixed costs + target profit)/contribution per unit

12
Q

Breakeven revenue

A

fixed costs / (1 - direct costs/price)

13
Q

Break-even target price

A

(fixed costs + direct costs) / production level

14
Q

Capacity Utilisation rate

A

Capacity utilisation measures a firm’s existing level of output as a proportion of its potential output.

Capacity utilisation = Actual output / Productive Capacity (maximum output)

15
Q

Limitations of a break-even analysis

A
  1. Information may be unreliable as it is based on forecasts and predictions - predictive model
  2. Assumes selling price stays the same regardless of output
  3. Assumes that fixed costs stay the same
  4. Assumes that variable costs per unit stays the same - ignoring purchasing economies
  5. Assumes all output is sold
  6. Only suitable for analysis of single products
  7. Only considers quantitive factors
16
Q

Advantages of a break-even analysis

A
  1. managers are able to read off from the graph the expected profit or loss to be made at any level of output
  2. Can show the margin of safety
17
Q

Target profit

A

Target profit = Total revenue - Total costs