The breakeven point for a company is the sales volume which will give the company a profit of £nil. If sales exceed the breakeven point (BEP) the company will make a profit. Breakeven analysis is often referred to as cost-volume-profit analysis.
We will assume that selling price per unit, variable cost per unit and fixed costs are all constant. Sales revenue and total costs will therefore both be linear.
If we call volume V then total revenue at the BEP will be price (or revenue per unit) x V.
Total costs = Fixed costs + (variable cost p.u. x V)
Accountants give the difference between the selling price per unit and variable cost per unit a special name – contribution. This is because it contributes towards covering the fixed costs.
So we can write the equation such that at the break-even point:
Example: ABC Co
ABC has the following information, relating to Product X, its only product:
Selling price £300 p.u.
Variable cost £160 p.u.
Fixed costs p.a. £140,000
If the plan is to produce and sell 1,200 units, what is the margin of safety? The margin of safety is the number of units above BEP expressed as a percentage of expected sales volume. In this case it would be:
In a situation where resources are scare, the scarce resource (limiting factor) should be used to produce the product that has the highest contribution per unit of limiting factor.
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