Types of costs and break even analysis

Revenue expenditure

expenditure on running costs

Direct cost

A cost that can be identified directly with each unit of output

Indirect cost

A cost that cannot be identified directly with each unit of output. Also called an overhead

Fixed cost

A cost that does not immediately change due to a change in output or the number of goods sold

Variable cost

A cost that does not immediately change due to a change in output or the number of goods sold

Stepped cost

A cost that is fixed up to a certain level of output, beyond which it is increases to a higher level of fixed costs

Semi variable cost

A cost where part of it is fixed and part of it is variable

Marginal cost

The cost of producing one extra unit

Contribution per unit

Selling price - variable costs per unit

Total contribution

Contribution per unit X number of units sold

Break even point meaning

Level of sales where revenue is equal to costs

Calculating break even point

Units= fixed costs/ contribution per unit

Revenue= fixed costs/ contribution sales ratio

Calculating the margin of safety

Actual level of sales - break even point

Contribution sales ratio

Contribution per unit / selling price

Level of sales needed to achieve a target profit

(Fixed costs + target profit) / contribution per unit

Revenue needed to achieve a target profit

(Fixed costs+ target profit) / contribution sales ratio

Benefits of break even analysis

• Assess the viability of a new business

• Set sales targets to help achieve the objectives of a business

• Evaluate changes to the business

• To support applications for bank loans

Limitations of break-even analysis

• Assumptions about costs selling prices may be incorrect

• Fixed costs eventually increase in order to go behind certain levels of output

• Assumptions about how likely a business is to achieve the target level of sales may be incorrect