Business

• Contribution

  Contribution per unit x number of units sold
• Profit

  Contribution less Fixed Costs
• Contribution per unit = £10 less £5 = £5
• Total Sales = 5,000 x £10 = £50,000
• Total Variable Costs = 5,000 x £5 = £25,000
• Total Contribution = £50,000 - £25,000 = £25,000
• Breakeven

  A business is said to "breakeven" when it is earning enough sales to cover all its costs
• Breakeven point (breakeven output)

  When total sales = total costs

  
• Key issues when looking at breakeven

  • At what level of production (output) does break-even take place?
  • What is the effect on break-even of changes in the business?
  • What business decisions can be taken which affect break-even and which will help improve profits?
• Alternative ways of calculating the breakeven point

  • A table (or spreadsheet) showing sales and costs over different levels of output
  • A formula which you can use to calculate break-even output
  • A graph which charts sales and costs

  
• Important assumptions for each approach

  • Selling price per unit stays the same, regardless of the amount produced
  • Variable costs vary in direct proportion to output – i.e. variable cost per unit is the same
  • All output is sold
  • Fixed costs do not vary with output – they stay the same
• The break-even output is somewhere between 6,000 and 7,000 units
• Contribution per unit

  Selling price per unit less variable cost per unit
• Using a formula to calculate break-even output

  1. Contribution per unit = selling price per unit less variable cost per unit

  2. Break-even output (units) = Fixed costs (£) / Contribution per unit (£)
• Break-even output = 6,666 units
• Using a chart to calculate break-even output

  1. Step 1: Produce two axes - vertical axis shows value of sales & costs, horizontal axis shows output

  2. Step 2: Add the fixed cost line

  3. Step 3: Add the variable costs line

  4. Step 4: Add the total cost line

  5. Step 5: Add the sales line

  6. Step 6: Identify the breakeven point

  
• Producing a breakeven chart

  1. Create vertical axis showing value of sales & costs

  2. Create horizontal axis showing output

  
• Breakeven chart

  • Vertical axis shows value of sales & costs
  • Horizontal axis shows output

  
• Adding fixed costs to the breakeven chart

  Draw a horizontal line showing fixed costs (e.g. £40,000)
• Fixed costs

  Costs that don't change with the level of output
• Adding variable costs to the breakeven chart

  Draw a straight line showing variable costs (e.g. £4 per unit)
• Variable costs

  Costs that vary directly with output
• Contribution

  The difference between total revenues and total variable costs
• Contribution per unit

  The difference between selling price per unit and variable cost per unit
• Breakeven output

  The output at which total revenues = total costs
• A budget is a financial plan for the future concerning the revenues and costs of a business
• Budgeting process

  • The process by which financial control is exercised in a business
  • Budgets for revenues and costs are prepared in advance and then compared with actual performance to establish any variances
  • Managers are responsible for controllable costs within their budgets
  • Managers take remedial action if the adverse variances are regarded as excessive
• Uses of budgets in business

  • Establish priorities & set targets
  • Turn objectives into practical reality
  • Provide direction and co-ordination
  • Assign responsibilities
  • Allocate resources
  • Communicate targets
  • Delegate without loss of control
  • Motivate staff
  • Improve efficiency
  • Forecast outcomes
  • Monitor performance
  • Control income and expenditure
• Principles of effective budgeting

  • Managerial responsibilities are clearly defined
  • Managers have a responsibility to adhere to their budgets
  • Performance is monitored against the budget
  • Corrective action is taken if results differ significantly from the budget
  • Unaccounted for variances are investigated
  • Departures from budgets are permitted only after approval from senior management
• Two main approaches to budgeting

  • Historical budgeting
  • Zero budgeting
• Historical budgeting

  Use last year's figures as the basis for the budget. Realistic in that it is based on actual results. However, circumstances may have changed (e.g. new products, lost customers, credit crunch). Does not encourage efficiency.
• Zero budgeting

  Budgeted costs & revenues are set to zero. Budget is based on new proposals for sales and costs – i.e. built from the bottom-up. Makes budgeting more complicated and time-consuming, but potentially more realistic.
• Three main types of budget

  • Revenue (or income) budget
  • Cost (or expenditure) budget
  • Profit budget
• Revenue (or income) budget

  Expected revenues & sales, broken down into more detail (products, locations, etc.)
• Cost (or expenditure) budget

  Expected costs based on sales budget, overheads and other fixed costs
• Profit budget

  Based on the combined sales and cost budgets, of great interest to stakeholders, may form basis for performance bonuses
• Budget

  • Expected revenues & sales
  • Expected costs based on sales budget
  • Overheads and other fixed costs
  • Profit budget
• Profit budget production

  1. Based on the combined sales and cost budgets

  2. Needs to be based on an informed analysis of the competitive (market) position of the business

  
• A budget is only as accurate and useful as the quality of the information used to produce it
• Sources of information used to inform the budgeting process

  • Financial performance in previous periods
  • Market research (trends, competitor activity, customer feedback)