a)      Break-even point.

The break-even point is the point at which neither a profit or a loss is incurred. Break-even occurs where total contribution is exactly equal to fixed cost and hence sales revenue is exactly equal to variable cost plus fixed cost. 

Break-even formulae

Knowledge of the break-even point is vital in business planning and decision-making, as it represents a crucial point in determining the success or failure of a business.

b)      Margin of safety.

The margin of safety is the amount of sales the business can afford to lose and still not make a loss. It is the difference between the budgeted sales volume (or revenue) and the budgeted break-even volume (or revenue). It can be expressed in units / products or € sales or as a percentage.

Margin of safety formulae

The margin of safety is vital in assessing the level of risk associated with a project. For example if budgeted sales for a restaurant were forecast at 20,000 covers with the break-even point calculated at 15,000 covers. The margin of safety is thus calculated at 5,000 covers (20,000 less 15,000). If the average spend per cover is €12 the in sales revenue, the margin of safety is €60,000 (5,000 x €12). The margin of safety can also be expressed as a percentage calculated at 25 per cent (20,000 - 15,000 ÷ 20,000). Thus actual sales could be 20 per cent less than budgeted and the business would still not make a loss.

         c)  Contribution margin

The contribution margin is another name for the contribution to sales ratio or C/S ratio. Contribution margin is simply the contribution divided by sales, multiplied by 100. If a C/S ratio of 60% is calculated it means that for every €100 in sales, contribution will on average amount to €60 with variable costs at €40. The C/S ratio is an important financial indicator because in some instances, key information may be unavailable to properly utilise the CVP model.  For example, total revenue may be presented without unit price or volume data.  In these situations the contribution to sales ratio (C/S ratio) can be used to calculate the break-even point in revenue. The break-even point in revenue, as well as the revenue required to achieve a target profit can be calculated using the following formulae based on the C/S ratio:

Formulae using C/S ratio