Chapter 6

Breakeven Charts

• Graphs which show how costs and revenue of a business change with sales and the level of sales the business must make in order to breakeven
• The breakeven point is where total cost=total revenue

Advantages:

• Expected loss and profit can be read
• Shows impact on sales due to certain business decisions
• Shows the safety margin

Drawbacks:

• Does not show the possibility that stocks may build up if not all goods are sold
• Fixed costs only remain constant if the scale of production doesn’t increase
• Many other aspects have to be taken into account which are not
• The costs and revenues are assumed to be drawn with a straight line

Calculation:

• Contribution= Selling Price- Variable Cost
• Breakeven= Total Fixed Cost / Contribution
• Average Cost Per Unit= Total Cost / Total Output

Economies of Scale

• The factors that lead to reduction in average costs as a business increases its size
• Purchasing Economies:
  reduced cost of each item bought by buying in large numbers

• Financial Economies:
  More sources of finance
  Easy to get loans
  Lower interest rates

• Marketing Economies:
  Bulk buying discount
  Ability to hire specialist staff
  Lower cost of advertisement

• Technical Economies:
  Specialization
  Research and development
  Better transport

• Risk-bearing Economies:
  Many suppliers
  Diversification

• Managerial Economies:
  Specialization
  Managers in every department

• Welfare Economies:
  Benefits whole economy

Diseconomies of Scale

• Factors which lead to an increase in average costs as a business grows beyond a certain size
• Management Diseconomies:
  Decision making takes time
  Disagreements
  Poor communication
  Less contact with customers

• Labor Diseconomies:
  Labor becomes bored
  Less cooperation
  No connection with management
  Less attentive
  Quality suffers
  Low morale
  Strikes and disruption

Forecasts

• Forecasts are the predictions of the future
• They can help predict:
  sales & demand
  exchange rate
  wage increases

Forecasting Methods

• Past sales could be used to calculate the trend (underlying movement of the direction of data overtime)
• Use a scatter diagram to draw the line of best fit (series of points which best show the trend of data)
• Panel consensus
• Market research surveys

Budgets

• Plans for the future containing numerical or financial targets
• Budgeting reviews past activities through comparing budgeted figures with actual figures
• It controls current business activity by keeping to targets
• It plans for the future by setting goals

Advantages:

• Provide motivational targets
• They can conduct a variance analysis to control how the business is performing by comparing budgets with the actual figures. The difference between the budget and the actual is the variance.
• Involves everyone in the company by setting targets
• Budgets are likely to be more realistic if everyone if worker participation is encouraged
• This could lead to higher productivity, morale and efficiency
• Increases efficient allocation of money