Accounting F014 breakeven analysis

Marginal cost

A marginal cost includes all the variable costs of materials, labour, direct expenses and variable overheads.

limiting factor

A scarcity of resource that prevents the organisation from producing all the volume for which there is sales demand e.g. a limit on the machine hours or the materials available for production.

fixed cost

A total fixed cost does not change as the volume of production increases or decreases. A fixed cost per unit will decrease ad volume increases because the total cost is being spread over a greater number of units.

Make or buy decision

when a business needs to decide whether it should make or buy the goods it is selling. The general rule is that if the variable cost of making the item is less than the purchase price from another manufacturer, then the decision should be to make rather than to buy. But remember there could be other considerations such as quality and reliability issues.

Sensitivity Analysis

Also known as "what-if" analysis. All or some factors in the break-even model (contribution per unit, fixed costs, volume) are altered to see the impact on profits, the break-even point and margin of safety. A decision making process for management.

Mixed cost

Also known as semi-variable or semi-fixed cost. This is a cost that included both a fixed element and a variable element. For example, telephone costs may include a fixed rental change and then a variable change per call made.

P/V ratio

Profit/Volume Ratio measures the amount of contribution earned from sales as a % (also known as contribution to sales ratio). You can calculate this rather on a per unit basis or using totals for contribution and sales, depending on the information you have.

contribution

The difference between a sales price and the marginal( variable) cost of the goods.We say that each unit earns a contribution towards covering the fixed costs of the business. Once those fixed costs are covered, profit is made and the profit will increase by the amount of any increase in contribution because the fixed costs do not change with additional volume.

Margin of Safety

The difference between the expected volume of sales and the break-even volume. This is therefore the amount of sales volume that the business can afford not to make and still not make a loss. to show it as a %, divide the difference by the expected volume and times by 100.

breakeven

The volume of units that need to be sold in order for the business to earn a contribution that equals its fixed costs so that neither a profit to loss is made. Divide fixed cost by the contribution per unit.