Break even is
The point at which neither a profit nor a loss is made
Break even formula
£ Fixed costs / £ Contribution per unit = number of units to break even.
In order to use break even analysis we need ...
Selling price (per unit)
Costs of Product (var costs p/u & overhead costs, split fixed/var)
Limitations (max production capacity, max sales)
The margin of safety is...
...the amount by which sales exceed the break even point.
Can be :
Units
Amount £
%
Break even ; target profit
Just take the break even formula:
£ Fixed costs / £ contribution per unit = no. of units
... and add in the desired profit
£ Fixed costs (+ £ Target profit) / £ contribution per unit = no. of units
Break even : Profit Volume analysis
Contribution £
_______________ = profit volume ratio
Selling price £
Limiting factors are...
Those aspects of a business which restrict output.
Availability of materials
Availability of skilled labour
Availability of machine hours
Finance
Quantity of output which can be sold (market demand for the product)
Where there is no limiting factor a business should...
Concentrate on making/selling the product with the highest PVR.
When there IS a limiting factor the business should ...
Switch production to the product which gives the highest contribution from each unit of the limiting factor. (Eg contribution per direct labour hour)
The key to dealing with limiting factors is...
Maximise the contribution per unit (SP-VC) of limiting factor.
Eg. Contribution per unit / no. direct labour hours if these are limited.
Instead of
Contribution per unit / Selling price per unit.
Ie. If you are short of something make best use of what you have.
Where there is a maximum level of output for that product , make the maximum and then go to the next best
PV ratio (profit-volume ratio)
Same as
CS ratio (contribution-sales ratio)
£ Contribution
-—————— = PV (pro-vol) ratio or CS (contrib-sales) ratio.
£ Selling price
Report for MD (recommendations where there is a Limiting factor)
1. Calculate the Contribution per unit of limiting factor to make the decision.
2. Prepare the SPL using the number of units of output (not the number of units of limiting factor)
3. Where there is a max output for the selected product, spill over any unused limiting factor into production of next best product.
Remember to point out that fewer products causes a shortfall in the market. It may be difficult to re-establish these products after the limiting factor has been resolved.
‘Special Order’ pricing
Where a business uses spare capacity to make extra sales of its product at a lower price than its normal selling price.
Special order pricing is normally used ...
When business is profitable at current level of output (ie reached break-even)
Additional sales at ‘special order’ prices can be made at a selling price above marginal cost but below absorption cost.
In this way profits can be increased provided that the additional sales are spare capacity. (I think this means no increase in overheads)
The key to increasing profit from additional sales is to ensure that a contribution to profit is made from the special order.
The principles of marginal costing can also be used to establish the effect of changes in costs and revenues on the profit of the biz.
Best way to show changes is a columnar layout showing costs and revs as at present and then proposed changes.
Points to remember if using marginal costing principles to make short term decisions...
1. Fixed period costs must be covered. (A balance needs struck)
2. Separate markets for marginal cost (eg abroad)
3. Effect on customers. If using to attract new customers hard to up price
4. Problems of product launch on marginal cost basis.
5. Special edition products (use marginal costing techniques to sell off old model before launching new.)
Short term decisions are those...
...which affect the costs and revenues over the next few weeks and months.
