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September 8, 2019

Break Even Analysis and Contribution per unit (#Poll2Learn : 7 & 8)

I have started #Poll2Learn series where we will learn together by poll and explaining my point of view . You are welcome to correct me or provide your input .
Follow me on twitter to participate in poll.


The correct answer for #Poll2Learn :7 is reward the salesperson with promotion because he is not just smart salesperson but also knows finance and work betterment of his organization.
Surprised, you will surprise more for the correct answer of #Poll2Learn :8 , the correct answer is loss very much likely to decrease.
How is the Josh ???

I do not have any accounting background but I will try my level best to explain. To check if you understood the concept correctly I will ask #Poll2Learn :9 after this article.
To understand correct answers you will have to understand the following concepts, I would recommend to learn these concepts in details from other websites and Youtube videos.
  • Fixed Cost
  • Variable Cost
  • Contribution (per unit or Margin )
  • Break-Even Point

Variable costs vary based on the amount of output, while fixed costs are the same regardless of production output. Examples of variable costs include labor and the cost of raw materials, while fixed costs may include lease and rental payments, insurance, and interest payments.

Contribution is Contribution of each unit toward organization bottom line (Profit).
Contribution = Selling price per unit - Variable cost per Unit 
Break-Even Point = Total Fixed Cost / Contribution 

Now came to #Poll2Learn :7 
The following diagram shows details of 3 different companies A, B and C

All 3 companies has different contribution per unit and different break-even point to go in profit if sales at 600 even though the total fixed cost is the same.
Total cost(fixed+ variable) per unit is 500 , if all these companies start selling below the current total cost 500, assume 450 
Will they ever able to break even after selling below cost ? 
Lets check 

Surprisingly, they can still break-even even after selling below cost price. However, these time break-even quantity is increased by 50 to 100% for A , B and C.
In nutshell, the company can make profits if Contribution is positive however, they will have to play volume game.
Let's assume in our poll 50k quantity has positive Contribution of Rs 200 per unit even at the low price of 450 then our smart salesperson did the smart deal, if Contribution is negative at that price then we could have fired him.
This strategy will reduce net profit margin but can be applied in recession time or bad time for company.

Now move to #Poll2Learn : 8 
We already know that if Contribution is positive then profit increases 
What about the loss-making company?

You can see initially loss of 8 lakhs but after selling an additional 500 Units @ 440 ( below the existing cost of 500), loss of organization reduced by 95k instead of most of you expected increase in loss .

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