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Break-even analysis 3.3 (Aspects (Break-even point (BEP): The amount of…
Break-even analysis 3.3
Contribution
Total contribution: unit contribution x output. If total contribution exceeds the fixed costs for the period, than the surplus is profit. If it is less then a loss has been made.
Contribution/unit: Selling price of a product - direct costs of the unit. If the selling price of the item is greater than the direct costs, than a contribution has been made. This is NOT PROFIT as fixed costs have need been subtracted yet.
Evaluation
Advantages
Provides useful guidelines to management on break-even points, safety margins and profit/loss levels at different rates of outputs.
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Can be used to assist managers when making important decisions e.g. location, whether to buy new equipment or what to invest in etc.
Disadvantages
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Not all costs can be classified into fixed and variable costs. Semi-variable costs makes it more compelx.
The assumption that costs and revenues are always shown by straight curves is unrealistic. Not all variable costs change as smoothly with output.
There is no allowance made for stock levels on the chart. It is assumed that all unit produced are sold... Unlikely
Aspects
Break-even point (BEP): The amount of revenue needed to cover both fixed and variable costs so that the business breaks even.
If the monthly fixed costs of a law practice are €60 000, lawyers are paid €15/hour and clients are charged a price of €30/hour, break-even revenue =
Margin of safety: The amount by which the output level exceeds the break-even output. It is a useful indication of how much sales could fall without the firm falling into a loss.
Target price: The price the business will need to set if breakeven is to occur at a certain time.
e.g. A business wants to break even at a level of production of 1000 units each month with direct costs at €3 per unit and fixed costs €6000 per month, what price must it charge?
Target profit: The BEP formula can be used if a business wants to use the target profit level to establish the level of output required to achieve BEP. This might be used by a business who has fixed rates of return as an objective and the purpose is to calculate the number of sales needed to achieve this point.
The target is €25 000, fixed costs are €200 000 and contribution/unit of €50. The level of output needed to earn the target profit is: