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OBJECTIVES. You should be able to:. Distinguish between fixed costs and variable costs. Use knowledge of this distinction to deduce the break-even point for some activity. Make decisions on the use of space capacity, using knowledge of the relationship between fixed and variable costs.

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OBJECTIVES

You should be able to:

Distinguish between fixed costs and variable costs

Use knowledge of this distinction to deduce the break-even point for some activity

Make decisions on the use of space capacity, using knowledge of the relationship between fixed and variable costs

Make decisions about the acceptance or rejection of a contract or activity, based on knowledge of the relationship between fixed and variable costs

Cost-volume-profit analysis


Costs may be broadly classified as

Those that stay fixed (the same) when changes occur to the volume of activity

Fixed

Those that vary according to the volume of activity

Variable

The behaviour of costs


Cost (£)

F

0

Volume of activity (units of output)

Graph of fixed cost(s) against the volume of activity


Rent cost (£)

R

0

Volume of activity

Graph of rent cost against the volume of activity


Cost (£)

0

Volume of activity

Graph of variable costs against the volume of activity


Graph of electricity cost against the volume of activity

The slope of this line gives the variable cost per unit of activity

Electricity cost (£)

Fixed costelement

0

Volume of activity


Cost (£)

Total cost

Variable costs

F

Fixed costs

0

Volume of activity (units of output)

Graph of total cost against the volume of activity


Total sales revenue

Cost (£)

Break-even point

Total cost

Variable costs

F

Fixed costs

0

Volume of activity (units of output)

Break-even chart


Fixed costsSales revenue per unit – Variable costs per unit

b =

Calculating the break-even point


OHT 7.10a

5

Totalcosts

Totalrevenue

Cost (£000)

4

3

Break-evenpoint

2

1

Fixed costs

0

100

200

300

400

500

Volume of activity (number of baskets)

Break-even chart for Cottage Industries’ basket-making without the machine


OHT 7.10b

6

Cost (£000)

5

Totalrevenue

Totalcosts

4

3

Break-evenpoint

2

1

Fixed costs

0

100

200

300

400

500

Volume of activity (number of baskets)

Break-even chart for Cottage Industries’ basket-making with the machine


OHT 7.12

The effect of operating gearing


OHT 7.12

Profit (£)

Break-even point

Profit

0

Volume of activity

Fixed cost

Loss

Loss (£)

Profit-volume chart


OHT 7.13

Three general problems

Non-linear relationships

Stepped fixed costs

Multi-product businesses

Weaknesses of break-even analysis


OHT 7.14

Can be used for the following short-term decisions:

Accepting/rejecting special contracts

The most effective use of scarce resources

Make-or-buy decisions

Closing or continuation decisions

Marginal analysis


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