Cost/Revenues - Breakeven point

Tjcgti

Hi all,

I have a quick question. Just on the chapter about Short-term Decision Making and studying the Breakeven point.
Just something that confuses me:

How does Sales Revenue = Variable Costs + Fixed Costs?

I know this will get amended to Sales Revenue - Variable Costs = Fixed Costs however I just can't see the how Variable/Fixed costs = Sales revenue?

Sales revenue isn't worked out by adding these costs together is it?

(possibly stupid question)

Thanks

SandyHood

How does Sales Revenue = Variable Costs + Fixed Costs?

It doesn't

Well it it only rarely applies.
If you make a loss or a profit it certainly doesn't apply.


Sales revenue is dependent on how many units you sell and how much the customers pay for each of them

Variable cost is dependent on the number of units sold and the variable cost of each

Fixed cost is independent

So as both sales revenue and variable cost use the number of units sold we can calculate something called contribution per unit

This is price less variable cost per unit.

When you know the contribution per unit you can use it with the fixed cost to find the point where

Sales Revenue = Variable Costs + Fixed Costs (the break even point)

By dividing the total fixed costs by the contribution per unit you find the number of units that you need to sell to break even.

Put these numbers together and see for yourself

Price per product £40
Variable cost per product £12.50

Fixed costs £5,500

How many must I sell to break even, and have an equation where Sales Revenue = Variable Costs + Fixed Costs?

Tjcgti

So if it doesn't (or rarely happens) why is this made to look like this? Sorry i'm just confused as to why it states it if the variable/fixed costs don't equal the Sales revenue.
Is it all just to find the correct forumla to get the Breakeven?

Price sold for - Variable cost


£40.00 - £12.50 = £27.50 which is the Contribution per unit?

Divide Fixed cost by Contribution per unit. £5,500 / £27.50 = £200.00. So this would be the Breakeven.

Can I also ask you this?

The books states that Sales revenue -Variable costs is = Contribution.
So: Contribution = Fixed Costs.

Then states the following equation:

Contribution per unit x break-even point (units) = Fixed Costs

To me this is saying that Contribution (fixed costs) x break-even point = Fixed costs (contribution)
Due to the book saying that Contribution = Fixed costs

Cleary I am wrong, I know, but is there a reason they have stated that in the book? I know that Sales less Variable costs = Contribution how does it equal Fixed costs?

ajm

The contribution pays for the fixed costs and then any extra is profit.

Sales revenue = Variable cost + fixed cost + Profit

Sales revenue - variable cost = contribution

So contribution = Fixed cost + Profit

In your example you have £5500 fixed costs to cover before you make any profit. As the contribution per unit is £27.50 you have to sell 5500/27.50 = 200 units to break even. Any extra units sold will give you £27.50 profit each.

Working it backwards 200 units (break even point) x £27.50 (contribution) = £5500 (fixed costs)

If you sold 300 units your contribution would be 300 x £27.50 = £8250. As there are £5500 fixed costs that leaves you with 8250-5500= £2750 profit. As you know the break even point is 200 units you could also say you have sold 100 extra units so could work out the profit as 100 x £27.50 = £2750.

Hope that helps!

ajm

Also, to work out the breakeven in £ you multiply the breakeven point in units by the sales price:

200 units x £40 = £8000

Tjcgti

Yes both answers make sense thanks

I think its just me going deeper than I should be really. How much I would have loved to be taught at college with a tutor.

Its funny with accounts as loads of effort goes into it just to find that 1 figure at the end. Looking forward to passing this exam on wednesday!! (i hope)

ajm

Good luck with the exam!

I've just reread your first post and I have realised what they are trying to say with

Sales Revenue = Variable Costs + Fixed Costs

As there is no profit (or loss) at the breakeven point the equation is correct but only for the breakeven point itself. At that point the contribution does equal fixed costs because there is no profit.

Tjcgti

Thanks for help. I have memorised the forumlas now so should be all right and makes sense.
I've been a bit rushed as had to learn over half the book in 2 weeks.

SandyHood

Tjcgti

Good luck with your exam.
I recommend examples where you apply your studies.

The book is written in such a way that makes it correct, but you need real understanding.

Next time you catch a bus, look around and think. If the fixed costs of running this bus for a day were £200 and everyone on it pays £0.50 of which £0.10 is the variable cost of me having a ticket etc how many people do they need on this bus to:

1. break even
2. make £50 profit

Then look at whatever it is your work sells and make the same assumptions.

When you can apply a topic, you understand more than merely rote learning formulae.