Break even analysis is used by businesses to determine the sales volume needed to cover total costs. It is calculated by dividing fixed costs by the unit contribution. Unit contribution is determined by subtracting variable costs from selling price. This allows businesses to set sales targets and understand their margin of safety. Budgets are also important for businesses to control expenditures and understand cash flow. There are expenditure, operating and cash flow budgets. Properly controlling budgets and costs is crucial to avoiding debt spirals and ensuring profitability.

1. Unit 2 Assignment 5
Lewis Appleton 1 Mr McColgan
Break Even
Break even is what businesses use to find out what level of sales will be able to make them break even in terms
of profit and loss. To find the point of break even the fixed costs is divided by the contribution of units. To find
the contribution of units the selling price is taken away from the variable cost of each unit. By calculating the
break-even point businesses will be able to see how much they actually need to sell to start gaining positive
revenue and therefore can set business objectives to meet this. The business can also find out where they would
actually make a loss. This is called the margin of safety and is calculated by taking away the break-even point
from the actual sales.
The contribution is the profit that is actually made on the individual products. It is used to find how many
products or services have to be sold to cover the costs and this applies to both variable and fixed products. The
difference between the variable costs and the sales is the contribution.
Formula
Break-even point = Fixed costs / Unit contribution
Unit contribution = selling price – variable cost
Benefits and limitations
Benefits
Through the use of computers and applications that use spreadsheets with formulas the data results can be
provided very quickly.
Investors can use the information to their advantage and decide if they should invest into smaller businesses.
This is useful to small businesses because it allows them to determine the outcome of their sales changing.
This requires a miniscule amount of training and is very easy to apply.
Limitations
One of the bad things is that the situation can appear to be too simplified because there may be certain
customers that may get cheaper rates because of their relationship with the business.
The break-even also can go out of date quickly because of the changing economy and the costs and prices for
both the raw materials and the final product can change at any point and are unpredictable.

2. Unit 2 Assignment 5
Lewis Appleton 2 Mr McColgan
The data is only useful for finding out the future costs and sales.
The economy scale is not taken into account where the costs may have changed when higher quantities of
supplies are purchased.
The data is hard to apply when a business is selling a large range of products that have differing amounts
covering the fixed costs.
For the information to be useful there needs to be relevant research into the market that’s supports it and the
predictions about the economy.
Budget
There are three types of budget that are used by businesses;
Expenditurebudget
This type of budget is vital for planning a start up. Before the business starts trading they are likely to already
incur costs such as licensing, this means that the business needs to already have enough cash available for
these costs. If the business fails to control these costs then it is likely to lead to failure as a business. This type of
budget needs to be in great detail. Some of these costs may be; building and location costs, equipment and
computers, legal costs, and employee costs.
Operatingbudget
This type of budget focuses on the management of current expenses within a business. There may be provisions
for transactions in the future or additional expenses. This type of budget is used to see how much income is
needed to operate and still be able to pay their expenses. The operating budget may include the sales and costs
of goods.
Cash flow budget
This type of budget shows how much the business is expecting to make over the year. The way it does this is by
calculating the payments made. To use this they take away the costs of expenses. Both the cash income and
expenses are estimated this way. After finding the income and expenses for the year a business can then use a
cash flow budget to estimate what the cash flow may be for the following year.
Purpose
A budget is needed to know where the money you have is going to be spent. It allows money to be planned for
certain expenditures. Budgets can be used to plan for long term future aspirations such as a new house,
retirement or particular goals. If budgets were not planned then expenses may be more than income and if
there is not an amount left for something such as rent or mortgage repayments there can be severe
consequences.
Budget problems
The main problems with budgets are that the slightest changes means the budget will need to be adjusted.
There may be shifts because of new products, new competitors and changes in consumer demand. If the
budget is a set budget such as a cash flow budget then the small change can make the whole budget
unreliable.

3. Unit 2 Assignment 5
Lewis Appleton 3 Mr McColgan
What can be done to combat these problems?
To combat these problems it is useful to have provisions in place should these changes happen, there needs to
be a degree of flexibility in the budget. Another way to combat budget problems is to not rely on one budget
and have multiple budget types.
Why costs and budgets need to becontrolled
In a business you would need to know what you have available to spend and the costs that you expect to be
paying. If the budget was not controlled and costs exceeded the budget then there will be a negative balance.
This way it is possible to enter a debt spiral without even realizing it. Therefore it is important to control
budgets to ensure that as a business not to fail, as a person not to enter debt. This also applies to the fact that
large businesses have the primary goal of gaining a profit and using a budget will efficiently do this.
Problems
If budgets were not controlled then it is highly likely that a business is not going to make a profit or at least an
efficient profit. They will not know what they are spending on things such as raw materials; this means if they
pay a certain amount the first time, the second purchase could be at a much higher rate compared to other
suppliers. If a business was to overspend its budget it will have a negative balance and therefore will be making
a loss and if this continues to build up then they will either enter a debt spiral or fail as a business.
A debt spiral is when a deficit continues to worsen. An example of this is having £100 income and £150
outcome. The first time there will be a £50 deficit, the second time if they have the same expenses they will
have to pay off the deficit first and they will be left with £50 income and £150 outcome so they will then have a
£100 deficit. This continues to increase and can be prevented with a good budget.
Without a budget a business also has the disadvantage of not being able to predict future income and
expenditure, this is because they would not have noted down their expenditures and incomes. They may have
the total amount of ± profit but this is a far less reliable piece of data than the total costs of expenditure and
income.