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Unit 5: Financial Management

The average spending power of the customer: This is calculated by dividing the total sales Notes
by the number of the customers served.

Fixed Costs: Expenses such as rent, rates, insurance, depreciation, wages salaries can be
divided by 52 (number of weeks in a year) to calculate the average fixed costs per week.
Variable Costs: This can be calculated as a percentage of the turnover figure.

5.5.2 Assumptions of Break-even Analysis

The break-even analysis is based on the following assumptions:

All costs can be separated into fixed and variable components.
Variable cost per unit remains constant and total variable cost varies in direct proportion
to the volume of production.

Total fixed cost remains constant.
Selling price per unit does not change as volume changes.
Productivity per worker does not change.
There will be no change in the general price level.
Then there is the concept of contribution. Contribution is the difference between sales and the
variable cost. The formula for contribution can be shown as:
Contribution = Sales – Variable Cost
Also, contribution = Fixed cost +/– Profit/ Loss

Therefore it implies,
Sales - Variable Cost = Fixed cost +/– Profit/ Loss
If any of the three factors are known, the fourth factor can be found out by using the above
equation.

Example:
Let Sales = ` 10,000
VC = ` 5000
FC = ` 4000

Using Sales – Variable Cost = Fixed cost +/– Profit/Loss
` 10000 – ` 5000 = ` 4000 + Profit
Profit = ` 1000
The next important concept is of Profit–Volume ratio (P/V ratio)

P/V Ratio = Contribution /Sales
This implies P/V ratio = (Sales – Variable cost) /Sales
Or (Fixed Cost +/- Profit/ Loss)/ Sales
And also P/V ratio = Change in Contribution/Change in Sales

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