Chapter 32- Break-even

Question 1

Contribution

Answer 1

The amount of money left over after variable costs have been subtracted from revenue

Contribution per unit = Selling price – Variable cost

Total contribution = Total revenue – Total variable cost

Question 2

Margin of Safety

Answer 2

The range of output between the break even and the current level of output, over which a profit is made. This can be seen by current level of output - break even.

Question 3

What is meant by Break-Even (definition)

Answer 3

-Breaking even means a business has generated enough revenue to cover its total costs, but not so much that it has made a profit

Break-even level of output = Fixed costs /Contribution (selling price – variable cost per unit)

Question 4

What does the break even chart show.

Answer 4

• Businesses may compile a break-even chart that plots their fixed costs, total costs and sales revenue to calculate their break-even point.
• Break even charts are useful to entrepreneurs because they provide a visual representation for how many units need to be sold to break even. They also display how much profit (Margin of safety) or loss will be achieved at different levels of output.

Question 5

List of advantages of Break-Even Output

Answer 5

• Decision making tool. It helps entrepreneurs determine if their business venture is even viable. Entrepreneurs can calculate how many sales they would need to make in order to cover their total costs and if they feel that target is not achievable. They can quickly see that they don’t have a viable, profitable business concept.
• Reduces risk attached. Break even analysis can be used to estimate the time taken and level of demand required for break-even to be achieved. Evidence of this may be required before banks are willing to provide funding.
• Price setting tool. Can be used to see how changes in their selling price will affect their break-even level of output as well as profits or losses they may make.
• Scenario planning tool. Can be used to investigate how changes in fixed or variable costs could affect the break-even point and viability of the business venture. May encourage entrepreneurs to investigate means of lowering their costs, sourcing cheaper locations, insurance or suppliers

Question 6

List of disadvantages of Break-Even Output

Answer 6

• Poor accuracy. First time entrepreneurs may find it difficult to accurately cost their business or determine what price customers are willing to pay. If any of the data is inaccurate, it means decisions are being made based on miscalculated figures.
• Limited in usefulness. Only informs an entrepreneur how many units needed to break even. It does not guarantee there will be sufficient demand for this to be achieved and may lead to too much money being spent in inventory and raw materials, leading to an oversupply of unsold products.
• Accounts only for a given set of conditions. Break even analysis becomes difficult to rely on in times of varied wage costs, rental costs or spikes in raw material costs which continuously change the break-even output point.

Question 7

How useful is Break-Even Analysis

Answer 7

• When breakeven is inaccurate, it is less useful. Businesses that find it most useful, start-ups, also will find it the hardest to accurately calculate. Without previous records of how much different costs might be or what customers are prepared to pay, entrepreneurs will resort to guessing.
• Therefore, accuracy is key. If an entrepreneur can forecast their fixed costs, variable costs and selling price with a strong degree of certainty – then break-even analysis is incredibly useful. It can be a dependable planning tool