3.5 Break Even Analysis

Question 1

What is contribution

Answer 1

The difference between the selling price and the variable cost

Question 2

How to calculate contribution per unit?

Answer 2

Selling price per unit - VC per unit

Question 3

What two formulae can be used to work out total contribution

Answer 3

Total contribution = total revenue - total variable cost OR contribution per unit x number of units sold

Question 4

Contribution is used to pay…

Answer 4

Fixed costs

Question 5

Where is the break even output?

Answer 5

Where contribution = fixed costs

Question 6

Break even output equation

Answer 6

Fixed costs / contribution per unit

Question 7

What goes on what axis when draw a break even chart

Answer 7

Out on orientalists axis and costs and revenue on vertical axis

Question 8

Where is the break even output on the break even chart

Answer 8

Where revenue crosses the total cost line

Question 9

What lines need to be plotted on the break even chart

Answer 9

• Fixed costs
• total cost
• Revenue
• Break even output

Question 10

What is margin of safety

Answer 10

The amount between actual output and break even

Question 11

How to calculate margin of safety

Answer 11

Actual output - break even output = Margin of safety

Question 12

Advantages of break even analysis

Answer 12

• Easy to do
• its quick / Managers can see break even output and margin of safety so know whether to cut cost or increases sales
• Allows business to forecast how changes in sales affects costs revenues and profit, most importantly, how changes in price and cost will affect how much they need to sell
• Can help persuade banks to give them loans
• Helps influence decisions on whether to release new products or not (if a business needs to sell unrealistic volumes of products they may decide not to launch the product)

Question 13

Disadvantages of break even analysis

Answer 13

• Assumes that VC rise steadily which isn’t the case (businesses get discounts for buying in bulk so costs don’t go up in direct proportion to output
• Most businesses sell multiple different products so can get complicated
• If data is wrong results are wrong
• Break even analysis assumes that a business sells all its product which isn’t always the case (restaurant may throw away food if there aren’t enough customers)
• break even analysis only tells you how much you need to sell, doesn’t tell u how much you’re going to sell