Craig Dudden Contribution Learning Objective To be able to calculate the different forms of contribution. (E) To be able to describe the relationship between contribution and profit. (C) To understand the importance of contribution to break even analysis (A)

Craig Dudden Contribution We need to look at two different types of contribution. Contribution per unit Total Contribution

Craig Dudden Contribution per unit This shows us the CONTRIBUTION each unit makes towards paying off the fixed costs. Contribution per unit is calculated by: Selling price per unit – Variable Cost per unit

Craig Dudden Contribution per unit Attempt the following question. Barry’s Butchers sells packs of sausages at £3. The variable costs incurred total £1.20. Work out the contribution per unit.

Craig Dudden Total Contribution This shows us the total CONTRIBUTION towards a businesses fixed costs from the total sales. Total contribution is calculated by: Contribution per unit x Total number of sales

Craig Dudden Total Contribution Attempt the following question. Barry’s Butchers sells packs of sausages at £3. The variable costs incurred total £1.20. Work out the contribution per unit. Now try the question below! If Barry’s Butchers were to sell 1250 packs of sausages could you work out the total contribution?

Craig Dudden Contribution and profit Contribution can be used to calculate the profit or loss of a business. Profit/loss = Total contribution – Fixed Costs So if Barry’s Butchers had fixed costs of £2000, would the business be making a profit or loss? How much?

Craig Dudden Contribution Pricing Some businesses choose to price their product/service using contribution. This means that a business will set a price that always covers its variable costs. At the same time it is a risky strategy as it ignores the level of fixed costs. Usually used when fixed costs are low or a business is familiar with the fixed costs that need to be covered.

Craig Dudden Case Study AblePrint Ltd have sold 5000 brochures at £2.50 each. For each brochure AblePrint Ltd had to pay 45p for ink, 35p for paper and 70p for other variable costs. AblePrint Ltd has fixed costs of £3500. Calculate – a) Contribution per unit b) Total contribution c) Profit/Loss

Craig Dudden Question Gordon has set up a new business. He has worked out he will have a contribution per unit of £8, but his fixed costs come in at £4328. Can you help Gordon work out how many units he must sell to cover his fixed costs? If you have managed to work this out, you have just calculated the Break-even point!

Craig Dudden Break even video

Learning Objectives: To be able to calculate the break even output (E) To be able to create and interpret a break even graph (C) To be able to analyse and evaluate the effectiveness of break even analysis (A)

Break Even Analysis …determines the point at which a business neither makes a profit or loss. … all costs are covered by a particular volume of output

Calculating Break even We first need to know 3 things: Fixed Costs Variable Costs Selling Price The calculation to determine the break even point is: _______Fixed Costs_______ Contribution per unit

Calculating Break Even The formula from the last slide will determine the level of output needed in order to stop making a loss and start making a profit. We can also use a graphical method to work out the break even point.

Mp3 Player Expected selling price £150 Direct costs (variable costs) Indirect costs (Fixed costs) Direct materials Direct labour Direct expenses £50 £30 £20 £100 Factory rent £50,000 p.a (per annum) a) Contribution per unit = Selling price - Variable costs £50 = £150 - £100 b) Break Even Point is calculated by: c) at BEP:Total Costs= Total Revenue (1,000 units x VC £100)+ FC £50,000 = 1,000 units x SP £150 £150,000 = £150,000 £50,000 £50 = 1,000 units

Break Even Chart Takes considerable time to work out the BEP using this method , , , , , ,000 75,000 50,000 25,000 Fixed costs (FC) Variable costs (VC) Total Revenue (TR) Total Costs (TC) Volume or Output (units) Cost, Revenue (£)

Activity

Uses of Break Even Analysis Break even analysis is particular useful when making decisions regarding the launch of new products or services, or diversification into new markets. When launching a new product it is important to know the level of output and sales needed to break even. This can be calculated by dividing fixed costs by contribution per unit.

Craig Dudden Limitations of break even The main limitation of break even is the fact it is only a prediction. It also does not account for economies of scale that may be achieved. It relies on a fixed price level and costs remaining at the same level.

Margin of Safety From the break even quantity we can calculate the excess of sales over break even. This is known as the margin of safety. The formula is: actual output minus break even output. The higher the margin of safety is, the greater the profits. In fact, think of it in terms of once break even has been reached, each unit contribution now adds to the firm’s profits. If we multiply the margin of safety by contribution per unit we get the level of profits. Profit = margin of safety X contribution per unit We can vary the formula to calculate the level of output needed to achieve a target level of profits. What we do here is to add the profit target to fixed costs and the simply work out the number of unit contributions needed to achieve this level of profit. Thus, the formula is: Fixed costs + profit target Contribution per unit

Case Study Lauren opens a fashion accessories shop. Her fixed costs are £17,000. Lauren sells goods at £35 with variable costs per unit of £ Work out Laurens break even output. 2. Complete the below table (Output increasing by 100 each time). 3. Show Lauren’s break even graphically. 4. What is Laurens margin of safety if she sells 1200 units. OutputFixed Costs Variable Costs Total Costs Sales Revenue Profit/ Loss

Summary At the break even level of output and sales (note only when the output is sold does it contribute to sales revenue), is when the firm is neither making a profit nor a loss. It is when sales revenue covers costs, but no more than that. Logically, if output and sales are below the break even level then the firm is making a loss, whereas if output and sales are above the break even level then it is making a profit. The higher the level of output and sales above break even, the greater the profit.

Craig Dudden Activity Complete Examination Questions