Question

1) "Define a Contribution Margin Approach Income Statement".

(2) "Describe what is meant by Break-Even Point ".

(3) "Discuss what in what ways can the Break-Even Point (or Desired (Target) Profit Point) can be

        determined".

(4) "Discuss the benefits and uses of Break-Even Analysis".

(5) "Define Margin Of Safety and discuss its uses and benefits".

Answer 1

Question 1: Define Contribution Margin Approach Income Statement

What is Contribution Margin?

Generally Profit/Margin means income minus expenses. That is, Sales – Cost = Profit/Margin

Cost includes two types of cost. 1. Variable Cost 2.Fixed Cost

The profit after deducting variable cost from Sales is known as contribution Margin

Contribution Margin = Sales - Variable Cost Net Profit = Sales – Variable Cost – Fixed Cost (or) Net Profit = Contribution Margin – Fixed Cost

The profit after deducting variable cost and fixed cost from sales is known as Net profit.

Contribution Margin Income Statement

Contribution Margin income statement is the income statement in which Variable cost are deducted from Sales to arrive Contribution Margin and Fixed cost are deducted from Contribution Margin to arrive net profit of the period.

Sales	***
Less: Variable Cost	***
Contribution Margin	***
Less: Fixed Cost	***
Net Profit	***

Question 2: Describe What is meant by Break Even Point?

Every business firm should run their business at profit. To earn profit, there must be excess income over all the expenses.

Expenses are two types: They are Variable Expenses and Fixed Expenses.

To earn the profit the income must be in excess of both these variable expenses and fixed expenses.

Every firm must calculate their sales which will cover at least these two expenses and left with zero profit and zero loss.

This sales level which covers exactly the variable and fixed cost and gives no profit and no loss is known as Break Even Point or Break Even Sales where total revenue(sales) is equal to total cost. Break Even Point is also called as No Profit No Loss Zone.

Contribution Income Statement at Break Even Point Sales

                                                                                    

Sales	***
Less: Variable Cost	***
Contribution Margin	***
Less: Fixed Cost	***
Net Profit/Loss	NIL

Question No.3: How to Calculate Break Even Point of Desired Profit Point?

a) Break Even Point(Sales in quantity)

Step 1: Calculate Contribution Margin Per unit

Contribution margin Per unit = Selling Price per unit – Variable Cost per unit

Step 2: Calculate Break Even Point

Break Even Point (units) = Fixed Cost / Contribution per unit

Eg. Selling price of a product $.10, Variable cost per unit of the product $.6, Fixed expenses of the company $10,000 for the period.

Contribution Per unit = Selling Price – Variable Cos per unit = 10 - 6 = 4

Break Even point (quantity) = Fixed Cost / contribution Per unit = 10,000/4 = 2500 units.

Concept of the formula: The Contribution Margin of how much units will cover the total fixed cost of the company, If the company sells that much units, there will be no profit or no loss. This sales level will be break even point.

Other ways to calculate break even point

Break Even Point (Sales Volume in Dollars) = Fixed Cost / Total Contribution Margin x Present Sales in $

Break Even point (Sales Volume in Dollars) = Fixed Cost / PV Ratio

PV ratio is the percentage of contribution margin on sales

b) Desired Profit Point

Desired Profit Point(units) = Fixed Cost + Desired Profit / contribution per unit

Explanation: The same formula of the break even point is used to calculate desired profit point with a small addition that desired profit should be added to fixed cost. In break even point formula, the number of units’ contribution margin that covers the total fixed cost is calculated. In desired profit point, the number of units’ contribution margin that covers the total fixed cost and desired profit is calculated. This sales will cover fixed cost and give desired profit.

In the above example if the company wants a profit of $4,000, what will be the desired profit point

Desired profit point = Fixed cost + Desired profit / Contribution Per unit

                                        = 10,000 + 4,000 / 4

                                        = 14,000/4 = 3,500 units

If the company wants $4,000 profit, it must sell 3500 units.

Let us verify

Sales (3500x10)	35000
Less: Variable Cost (3500x6)	21000
Contribution Margin	14,000
Less: Fixed Cost	10,000
Net Profit	4,000

Question No.4 Discuss the benefits of break even analysis

Benefits of break even analysis

1. It indicates the lowest amount of business activity necessary to prevent losses.

2. if a company knows break even point and desired profit point, it can work to achieve the required amount of sales by employing all the resources they can.

3. It shows how changes in sales, fixed cost and variable cost will affect the profitability of the business.

Question No.5: Define Margin of Safety and discuss its benefits.

Margin of Safety is the excess of actual sales over break even sales. In the above example if the company sells 3000 units. The sales in dollars is 3000 x 10 = $30,000. But as we calculated the break even sales is 2500 units, that is , 2500 x 10 = $25000.

Margin of Safety = Actual Sales – Break Even Sales

                                = 30,000 – 25,000

                                = $5,000