Other businesses raise money in different ways. They may get a bank loan or may try to raise finance by getting a grant. Grants can be given to businesses by national or local government agencies for many different reasons. These include where the business is located, how big the business is, or if the business is an industry that has problems. The most common organisations to receive grants are in farming, manufacturing or tourism.
Provision of Appropriate Reserves to Address Emergencies/Crisis
Businesses have to make sure that they keep some money back at the end of each month in case an emergency should happen.
This ensures that if they do have problems, such as an unexpected expense, or there is a downturn in the market they have enough funds to continue in business.
Some accountants recommend that reserves should be maintained which allow the business to continue for at least 3 months in the event of emergency.
It is also important for businesses to have some reserves in the early stages of the business as it may be difficult to make accurate budget predictions and costs. Expenses may be higher than planned and income may be less. An emergency budget will allow the business to continue to trade.
BREAK-EVEN ANALYSIS
The break-even point is the level of output at which a business covers its total costs. In other words where total cost = total revenue. Anything produced & sold above this point is profit, anything below is loss.
THE PURPOSE OF BREAK-EVEN ANALYSIS
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Estimate the future level of output they will need to produce and sell in order to break-even or achieve a profit target
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Explore “what if scenarios” e.g. assess the likely impact of price changes upon the level of output needed to break even OR assess how changes in fixed and/or variable costs may affect the level of output necessary to break even
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Support applications for loans from banks and other financial institutions - the use of the technique may indicate good business sense as well as providing profit forecasts.
CALCULATING BREAK-EVEN POINT USING CONTRIBUTION
Calculating the break-even point for a product requires:
- the selling price of the product
- its fixed costs
- its variable costs per unit.
The break-even output level can be calculated by the formula:
Fixed Costs
BEP =
Contribution (selling price – variable cost per unit)
Contribution is the difference between revenue and variable costs. It is used to pay fixed costs and to provide profits.
EXAMPLE A firm selling tennis rackets has fixed costs of £1,000 and each racket costs them £20 to produce. The retail price of the rackets is £30. How many rackets does the firm have to sell to break-even?
£1,000 £1,000
BEP = = = 100 rackets
(£30 - £20) £10
TASK ONE
Armstrong Ltd manufactures computer desks in a small business unit, which it rents from the local council. The rent is currently £400 per month and other fixed costs add up to £100 per month. The desks are sold to computer retailers at a standard price of £60. Production is organised between five staff and the variable production costs are £35 per desk.
Calculate how many desks Armstrong Ltd would have to make in a month in order to break even.
CALCULATING BREAK-EVEN POINT USING TC AND TR
Another way of calculating the break-even point is to use the total costs and total revenue equation. In the case of the above example:
Total costs = fixed costs + variable costs
Or TC = £1,000 + £20Q
And Total revenue = price x quantity sold
Or TR = £30Q
Where Q is the quantity produced and sold. A firm will break-even where total cost is equal to total revenue. Therefore we can write:
TC = TR
£1,000 + £20Q = £30Q
To find Q we can calculate:
1,000 = 30Q - 20Q
1,000 = 10Q
1,000 = Q
10
100 = Q
TASK TWO
Using the same scenario as before, calculate the break-even point for Armstrong Ltd using the total costs and total revenue equation.
