Business 2.2.3 Break even

• Contribution:

  • Contribution ( per unit ) = the difference between the selling price per unit of a product and the variable cost per unit of making that product
  • Calculations:
  • Selling price per unit - variable cost per unit
  • Total revenue - Total variable costs
• Contribution:

  • Contribution per unit ‘contributes’ to the total fixed costs of a business
  • Once the total fixed costs of a business have been covered, then contribution per unit ‘contributes’ towards the profit of the business
  • Fixed costs / Contribution per unit = output ( number of units ) required to meet and cover fixed costs
• Contribution:

  • Total contribution = Not profit
  • Calculations:
  • Contribution per unit x total number of units sold
  • Total revenue - total variable costs
  • You can also calculate profit with: Total contribution - Total fixed costs = profit
• What is the definition for the break even point on a graph?

  • Where total revenue = total costs
  • The business is not making a profit or a loss
  • A business can work out what volume of sales / output it needs to cover its costs
• What is the calculation for break even?

  Fixed costs / Contribution per unit ( selling price per unit - variable cost per unit )
• What is the definition for Margin of Safety?

  Shows how much output can reduce / fall before reaching the break even point
• What is the calculation for margin of safety?

  Actual or Current level of output - break even output
• What is the purpose of a break-even chart?

  To identify the break-even point
• What does a break-even chart show?

  Sales revenue and costs
• What key information can be interpreted from a break-even chart?

  • Selling price per unit
  • Fixed costs
  • Variable cost per unit
  • Contribution per unit
  • Margin of safety
  • Profit/loss
• What was last year's actual output for the business?

  5,000 units
• What is the break-even point identified in the chart?

  4,000 units
• What is the selling price per unit based on the chart?

  £10
• How is the selling price per unit calculated?

  £50,000 total revenue / 5,000 units
• What are the fixed costs identified in the chart?

  £30,000
• What is the variable cost per unit?

  £2.50
• How is the variable cost per unit calculated?

  (£40,000 total costs - £30,000 fixed costs) / 4,000 units
• What is the contribution per unit?

  £7.50
• How is the contribution per unit calculated?

  £10 selling price - £2.50 variable cost
• What is the margin of safety?

  1,000 units
• How is the margin of safety calculated?

  5,000 actual output - 4,000 break-even point
• What happens below the break-even point of 4,000 units?

  The business will be making a loss
• What happens above the break-even point of 4,000 units?

  The business will be making a profit
• What is good practice when completing calculation questions in exams?

  • Calculation questions are worth 4 marks
  • Show all working steps
  • Double-check calculations for accuracy
• What are the benefits for break - even?

  • Allow a business to identify the level of output needed to make a profit which is useful for setting targets
  • Allows ‘what if’ analysis - to assess the effect on the Break even point from changes in selling price and costs
  • Start - up allows entrepreneur to see how much needs to be sold to break - even
  • Helps business obtain finance
  • Illustrates importance of keeping cost low
• What are the limitations of break even?

  • Often based on unrealistic assumptions EG. Variable costs remaining the same whatever the output is - as output rises - business may benefit from bulk - buying economies of scale which reduces variable cost per unit
  • Selling price unit may charge as some products are not sold at the same price at different levels of output EG. Reducing selling price per unit for bulk orders
  • Sales unlikely to be the same as output EG. Some build up of stocks or wasted output
  • Most businesses sell more than 1 product - break even = harder to calculate