BUSINESS ACCOUNTING - Break-even Analysis, Costing, Final Accounts, Ratio Analysis

BUSINESS ACCOUNTING
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Table of Contents
LO1. Knowing how to use break-even analysis as an assistance for business planning.................3
1.1 Using break-even analysis for the justification of a decision about a business project.............3
LO2. Understanding costing............................................................................................................5
2.1 Evaluation of a business decision using the techniques of management costing......................5
LO3. Understanding the significance of final accounts of a business.............................................7
3.1 Discussion of the reasons for the importance of final accounts to the stakeholders of a
business............................................................................................................................................7
LO4. Understanding ratio analysis..................................................................................................9
4.1 Evaluation of the financial state of a business through the application of the techniques of
ratio analysis....................................................................................................................................9
Reference list.................................................................................................................................14
Appendix........................................................................................................................................15
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LO1. Knowing how to use break-even analysis as an assistance for business planning
1.1 Using break-even analysis for the justification of a decision about a business project
Breakeven analysis is a technique in economics that involves the examination and computation
of the “margin of safety” of a company based on the associated costs and revenues collected by
the company (Richards, 2013). Through the analysis of the various price levels of a company
related to its various levels of demand, the company uses the breakeven analysis for determining
the level of sales required for covering the sum of all the fixed costs of the company. The
breakeven analysis helps a company in deriving a point at which the sales made or the revenues
earned by a company are equal to the costs spent by the company for production of goods.
The breakeven analysis plays an important role in decision-making (Drury, 2013). It especially
helps in the determination of the minimum sales that must be exceeded in order to make profit
from the business project. The breakeven analysis is useful for decision-making in a business
project as it helps in setting selling prices, management of costs and planning for profits. For
example, XYZ Ltd. Company wants to invest in a project of building a housing complex. The
investment for building a hotel is huge and thus the company requires effective decision-making
in order to find out whether project should be undertaken or not. The decision-making of this
project can be evaluated from the breakeven analysis in the following way –
The fixed costs and variable costs required for building the hotel is as follows –
FIXED COSTS VARIABLE COSTS
Labor $1500000 Labor $450
Insurance $300000 Raw Materials $190
Advertising $22000 Component parts $110
Utilities $3000
Total fixed costs $1825000 Total variable costs (per unit) $750
The cost of selling each flat is $1000 and the current level of sales is 8000 units. Therefore
breakeven point = Total fixed costs / Selling price of each unit – Variable cost of each unit =
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$1825000 / $1000 – $750 = 7300 units. Therefore, XYZ Ltd. requires selling 7300 units of flats
in the housing complex in order to reach a point where the costs spent for the project will be
equal to the revenues of the project. According to this analysis, the company can take decisions
regarding setting selling prices, management of costs and planning for profits. According to
Bodie et al. (2014), the risks of the company for undertaking the project can also be derived from
the breakeven analysis through the derivation of the MOS or the margin of safety of the project
with the following formula – MOS = (Current level of sales – Breakeven point / Current level of
sales) * 100
Thus, MOS of XYZ Ltd. = (8000 – 7300 / 8000) * 100 = 8.75%
This shows that the present level of sales of XYZ Ltd. can fall up to a percentage of 8.75 from
the present sales level. However, if the sales of the business project fall by more than 8.75%, it
can of great risks for the company. In this way, breakeven analysis helps a company in effective
decision-making related to a business project.
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