Break-Even Analysis - Cost Accounting Techniques, Cost Accounting Video Lecture | Cost Accounting - B Com

hi there in this business topic video
we're going to take a look at a specific
aspect of break-even analysis that's
really useful particularly if you want
to use break-even calculations to work
out the profit of a business this
concept called the margin of safety now
a quick reminder hopefully this is
familiar to you if not a useful reminder
of how we calculate the break-even
output the number of units at which
total revenues of the business equals
total costs in other words the point at
which your business is not making a loss
but neither is it making a profit where
total revenues equals total costs and
you need to be a familiar of course in
terms of how breakeven analysis is
constricted you need to understand how
revenues are calculated revenues are the
value of sales made by a business over a
particular period and you calculate
revenues by multiplying the selling
price per unit times by the number of
units sold and of course costs in
breakeven analysis very importantly are
broken down into two different types of
costs variable costs are those that vary
in relation to output units produced
units sold
fixed costs are the costs that do not
vary in relation to output and to
calculate total costs we have to
calculate variable costs plus fixed
costs now what I'll do is I'll just put
a brief illustration of the break-even
output calculation on the screen and
build it up so that we can then
introduce using this data this concept
called the margin of safety in this
example that we're going to put on the
screen and work through it's very simple
one there's one product product a it is
sold for 20 pounds per unit 20 pounds
each each unit has a variable cost of 8
pounds each and this business has fixed
costs of 25 thousand pounds per month so
if you were given that information you
could work out
by calculating revenue variable cost
fixed costs and total costs you can work
out what the break-even output is so
let's have a go first thing to do is to
calculate the revenues so we multiply
the unit sold on the left there by 20
pounds per unit to give the total
revenues next we calculate variable
costs again this is an easy calculation
it's the variable cost per unit
for example eight pounds times by the
unit sold the first line of the table
one thousand units that gives you 8,000
pounds worth of variable costs so at one
thousand units sold our contribution if
you remember that key term our
contribution is two thousand so a twenty
thousand pounds worth of revenue less
variable cost of eight thousand pounds
so our contribution if I had a column
for contribution would be twelve
thousand pounds
our fixed costs do not vary with output
so despite the increase in the unit sold
on the left-hand column
our fixed costs are fixed therefore they
are twenty five thousand pounds whatever
the level of output so to calculate
total costs we add together variable
costs plus the fixed costs to give that
column there that's now highlighted in
red so for example when we sell a
thousand units our total costs are
thirty three thousand pounds which
comprises twenty five thousand pounds
worth of fixed costs plus the eight
thousand pounds worth of variable costs
and of course as we know to calculate
profit or loss we take total revenue
less total costs and see what the number
comes out up and there it is so we can
see that at 1,000 units sold we make a
loss of thirteen thousand pounds because
our revenue of twenty thousand pounds
was not enough to cover our total costs
of thirty three thousand pounds in other
words add a thousand sold we have not
yet broken even and have we broken even
at two thousand units well it looks like
not quite so we've made a loss of a
thousand pounds so if even at two
thousand units we're not quite yet at
the break-even output
however certainly at 3,000 4,000 5,000
units we have started to generate a
profit which must mean that we have
exceeded the break-even output now
somewhere between 2,000 and 3,000 units
sold is the break-even output and of
course we know this very useful formula
we can use to calculate without it what
that is to calculate the break-even
output you divide fixed costs by the
contribution per unit fixed costs
divided by the contribution per unit
perhaps the most important formula
you'll ever use in breakeven so in our
case our fixed cost of 25,000 pounds per
month and we know that the contribution
per unit is 20 pounds of revenue less
eight pounds of variable cost so every
unit we sell contributes 12 pounds
towards our fixed costs and how many of
those do we need to cover the fixed cost
we divide one by the other so we need to
sell I've just rounded up very briefly
up to 2080 four units per month to reach
the break-even output 2084 now that then
sets us up nicely to understand what's
known as the margin of safety it's a
funny sounding term but it's a really
useful and very important one the margin
of safety is the difference in units
between what we actually produce or sell
and what the breakeven output is so if
we go back we saw in our example that
the breakeven output output for this
business is 2080 for units per month and
we know that the margin of safety is the
difference between that breakeven output
of 2084
and the actual output now let's just
illustrate that briefly imagine that we
have actual outputs of 5,000 units and
breakeven output of seven-and-a-half is
that more than the break of an output
we're clearly not it's two and a half
thousand units below the break-even
output however if we produce 10,000
units
and the break-even output was seven and
half thousand units we would have more
units than we need to break even and
therefore the margin of safety is
positive two and half thousand so
remember that the margin of safety is a
difference between the actual units that
you produce or sell and the break-even
output and ideally in any business
you're trying to find a positive margin
of safety because and this is the key
point to remember a business that
operates with a positive margin of
safety is profitable on the flip side a
negative margin of safety means that the
business is making losses and I'm going
to show you how you can prove that but
that's a really important point to
remember in order to be profitable you
have to have a positive margin of safety
in other words what you're actually
selling or producing is greater than the
break-even output and beauty of this is
that you could always prove the profit
of business but profit of the business
by using what we call to do the magic
formula profit is the margin of safety
in units times by the contribution per
units you don't believe me let's have a
look
profit is the margin of safety in units
times by other contribution per unit so
let's let's go back to our product a
example remember that one few minutes
ago we were selling a product for 20
pounds our fixed cost for 10 25 thousand
pounds and we knew that somewhere
between two thousand three thousand was
the break-even output and we calculated
it at I think it's 2080 for didn't we as
the break-even output now what happens
if our actual sales are four thousand
units now that would suggest a positive
margin of safety wouldn't it four
thousand units is higher than two
thousand and eighty four does that prove
does that create a profit of twenty
three thousand pounds let's have a look
the profit is the margin of safety which
in this case is four thousand units take
away breakeven output so our margin of
safety is one thousand nine
sixteen units times by the contribution
per unit which if you remember was 20
pounds less eight pounds variable cost
it was twelve pounds per unit wasn't it
so profit should be nineteen hundred and
sixteen units times by twelve pounds per
unit and if you do the calculations that
comes out at twenty two thousand nine
hundred ninety two pounds in other words
rounded up as the table suggested a
profit of twenty three thousand pounds
now in a subsequent video when we look
at how you can use break-even analysis
to help manage the business and improve
profitability we will look at how you
can improve the margin of safety but
just for now just remember the margin of
safety is the difference between the
actual output and the break-even output
so you can see that in terms of
improving or widening the margin of
safety which of course has the effect of
increasing profit there's a bunch of
things you can do you could try to
increase the contribution per unit
perhaps by raising selling prices or by
finding cheaper variable costs you could
try to lower the break-even output
either by lowering those fixed costs or
by turning some fixed costs into
variable costs and of course you can do
much more by trying to increase the
actual output what you sell that's has
that will have the effect normally of
widening or improving the margin of
safety but we'll look at that when we
come to using break-even analysis as a
way of analyzing how a business can
improve its profitability
so just to recap the margin of safety
it's a really useful concept in
break-even analysis it's the difference
between what you actually produce or
sell and the breakeven output so this
has been a short revision topic video on
one part of break-even analysis the
margin of safety