Breakeven Analysis

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  • Contribution margin per unit: sale price - variable cost
  • Breakeven units: fixed costs / contribution margin per unit
  • One cost-volume-profit analysis assumption is that costs are linear
  • One cost-volume-profit analysis assumption is that there is only one cost driver
  • One cost-volume-profit analysis assumption is that costs are defined as either fixed or variable
  • Contribution Margin Ratio = Contribution / Selling Price
  • The Contribution Margin Ratio is also knows as the Contribution to Sales Ratio
  • Breakeven in £: fixed costs / Contribution Margin Ratio
  • Margin of safety: budgeted sales units - breakeven sales units
  • The margin of safety is how much a company can underperform before beginning to make a loss
  • Operating Income = Net Income / (1 - Tax Rate)
  • One limitation of the cost-volume-profit analysis is that the linear cost assumption may not hold economies and diseconomies of scale are ignored
  • One limitation of the cost-volume-profit analysis is that it is difficult to apportion fixed costs between different products
  • One limitation of the cost-volume-profit analysis is that the time value of money is ignored
  • One limitation of the cost-volume-profit analysis is that the selling price must be the same for all customers
  • If resources are scarce, whatever product has the highest contribution per limiting factor should be produced.
  • The High-Low Method is used to separate a mixed cost into fixed and variable components if the mixed cost is linear
  • Variable cost per unit in the high-low method is the gradient of the line, calculated by using the highest and lowest given points of the line
  • The total fixed cost in the high-low method is the y-intercept
  • Operating Leverage = Contribution Margin / Operating Profit
  • Operating Leverage is also known as Operating Risk
  • Higher fixed costs increase operating leverage
  • A higher operating leverage means a company is more sensitive to a change in sales. If operating leverage is x, an increase in sales of 1 will increase operating profit by x%.