break even analysis- a comprehensive and clear description

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Break-Even AnalysisBreak-Even Analysis

Simplified for Better Simplified for Better UnderstandingUnderstanding

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Definition of Important factors Definition of Important factors

Marginal Costing:Marginal Costing:

Marginal costing necessiates analysis of Marginal costing necessiates analysis of costs into fixed and variable. It has been costs into fixed and variable. It has been designed to help the management to have designed to help the management to have a clear perspective on the effect of these a clear perspective on the effect of these two types of costs on the profitability two types of costs on the profitability margin and sales volume .margin and sales volume .


Cost-Volume-Profit RelationshipCost-Volume-Profit Relationship

This CVP( cost-volume-profit) analysis This CVP( cost-volume-profit) analysis pertains to management accounting pertains to management accounting where the results can be interpreted to where the results can be interpreted to know the know the

1.1. Actual cost of production under different Actual cost of production under different circumstancescircumstances

2.2. What has to be the volume of production?What has to be the volume of production?

3.3. What profit can be earned?What profit can be earned?

4.4. What is the difference between the selling What is the difference between the selling price and cost of production?price and cost of production?


ContributionContribution

Contribution is the difference between sales and Contribution is the difference between sales and the variable cost and referred to as “Gross the variable cost and referred to as “Gross margin.”margin.”

It is visualised as some sort of fund or pool out It is visualised as some sort of fund or pool out of which all fixed costs are to be met and to of which all fixed costs are to be met and to which each product has to contribute its share.which each product has to contribute its share.

The difference between contribution and fixed The difference between contribution and fixed cost is either profit or loss as the case may be.cost is either profit or loss as the case may be.


Variable or Marginal Cost Variable or Marginal Cost StatementStatement

Sales-Variable cost= Sales-Variable cost= ContributionContributionContribution-Fixed Cost= Contribution-Fixed Cost= ProfitProfit

Variable Cost StatementVariable Cost StatementSales Revenue Sales Revenue xxxxxxxxDirect Materials xxxxDirect Materials xxxxDirect Labour xxxx Direct Labour xxxx Variable Overhead Variable Overhead xxxxxxxxVariable Costs Variable Costs ((xxxxxxxx))Contribution Contribution xxxxxxxxFixed Overhead Fixed Overhead (xxxx)(xxxx)Profit Profit xxxxxxxx(- )Read as minus symbol(- )Read as minus symbol


Concept of ContributionConcept of Contribution

The concept of contribution is useful in The concept of contribution is useful in

Fixation of selling pricesFixation of selling prices

Determination of break-even pointDetermination of break-even point

Selection of product-mix for profit Selection of product-mix for profit maximisationmaximisation

Ascertainment of profitability of products, Ascertainment of profitability of products, departments etc.departments etc.


Contribution Margin RatioContribution Margin Ratio

The contribution margin is also useful for The contribution margin is also useful for determining the impact on profits of changes in determining the impact on profits of changes in sales. In particular, it can be used to estimate sales. In particular, it can be used to estimate the decline in profits if sales drops, and so is a the decline in profits if sales drops, and so is a standard tool in the formulation of budgets.standard tool in the formulation of budgets.

FormulaFormula: To calculate the contribution margin : To calculate the contribution margin ratio, divide the contribution margin by sales. ratio, divide the contribution margin by sales. The formula is:The formula is:

Contribution marginContribution marginSalesSales


How to Calculate Con.MarginHow to Calculate Con.Margin

Example: Example: Rs.Rs.Revenue 10,00,000Revenue 10,00,000Variable expenses 4,00,000 Variable expenses 4,00,000 ---------------- ---------------- Contribution margin 6,00,000Contribution margin 6,00,000Fixed expenses Fixed expenses 6,60,0006,60,000Net loss Net loss 60,00060,000


Break-Even AnalysisBreak-Even Analysis

In its In its narrow sensenarrow sense, it is that point where , it is that point where

Total Revenues=Total Expenses, i.e., theTotal Revenues=Total Expenses, i.e., the

point of zero profit.point of zero profit.

In a In a broader sensebroader sense, it denotes a system of, it denotes a system of

analysis that can be used to determine the analysis that can be used to determine the

probable profit at any level of operations.probable profit at any level of operations.


Definition of Break-Even PointDefinition of Break-Even Point

At the breakeven point of a business, At the breakeven point of a business, income is equal to expense and therefore income is equal to expense and therefore there is no gain or loss. there is no gain or loss.

It is the starting point from which an It is the starting point from which an increase in sales or a reduction in costs increase in sales or a reduction in costs generates a gain and a reduction in sales generates a gain and a reduction in sales or an increase in costs generates a loss. or an increase in costs generates a loss.


Why to calculate BE PointWhy to calculate BE Point

The breakeven point is an important reference The breakeven point is an important reference point that enters into planning and carrying out point that enters into planning and carrying out business activities.business activities. A clear understanding of the level of sales A clear understanding of the level of sales needed to cover all costs helps you to knowneeded to cover all costs helps you to know

1.1. How many units you must produce in the case How many units you must produce in the case of a manufacturing businessof a manufacturing business

2.2. How many units you need to purchase and sell, How many units you need to purchase and sell, in the case of a merchandising business. in the case of a merchandising business.

3.3. In a services business, the breakeven point In a services business, the breakeven point indicates the number of billable hours you must indicates the number of billable hours you must work in order to cover your costs. work in order to cover your costs.


Assumptions of CVP AnalysisAssumptions of CVP Analysis

1.1. Costs are differentiated into fixed and Costs are differentiated into fixed and variable components.variable components.

2.2. Fixed cost remains constant.Fixed cost remains constant.3.3. Variable costs as the name indicates Variable costs as the name indicates

vary in proportion with the volume.vary in proportion with the volume.4.4. Selling price does not change with Selling price does not change with

volume.volume.5.5. There is only one product or, in the case There is only one product or, in the case

of multiple products, sales mix remains of multiple products, sales mix remains constant.constant.


Assumptions of CVP AnalysisAssumptions of CVP Analysis

6. There will be no change in the general 6. There will be no change in the general price level.price level.7. Productivity per worker remains7. Productivity per worker remains unchanged.unchanged.8. There is synchronisation between 8. There is synchronisation between production and sales.production and sales.9. The efficiency of plant can be predicted.9. The efficiency of plant can be predicted.10. The principle of cost variability is valid.10. The principle of cost variability is valid.


What is fixed costWhat is fixed cost Fixed cost is invariable and has to be borne by the company regardless of Fixed cost is invariable and has to be borne by the company regardless of the level of sales.the level of sales.

ExamplesExamples::

1. The cost to rent an office, shop, warehouse, factory, or other facilities1. The cost to rent an office, shop, warehouse, factory, or other facilities

2. Base salaries and wages of employees; employee benefit plans, 2. Base salaries and wages of employees; employee benefit plans, maintenance contracts; contracts for cleaning and security services; maintenance contracts; contracts for cleaning and security services; advertising contracts; insuranceadvertising contracts; insurance

3. Base costs of utilities such as electricity, gas, water, and sewage3. Base costs of utilities such as electricity, gas, water, and sewage

4. Base costs of telephone land lines or cellular telephone; Internet connection; 4. Base costs of telephone land lines or cellular telephone; Internet connection; the monthly cost of a domain and website; real and personal property taxes; the monthly cost of a domain and website; real and personal property taxes; licenses and permits; depreciation and amortization; and interest and other licenses and permits; depreciation and amortization; and interest and other debt service expenses. debt service expenses.


What is variable costWhat is variable cost

The costs that are incurred in proportion to the level of The costs that are incurred in proportion to the level of sales.sales.

Examples:Examples:1.1. Raw materials and suppliesRaw materials and supplies2.2. FreightFreight3.3. Rental of machinery, equipment, and tools for specific Rental of machinery, equipment, and tools for specific

jobsjobs4.4. FuelFuel5.5. Employee overtime pay; temporary contract labor; Employee overtime pay; temporary contract labor;

repairs and maintenance; office supplies; telephone repairs and maintenance; office supplies; telephone calls; travel expenses; and sales commissions. calls; travel expenses; and sales commissions.


What is Semi-variable costWhat is Semi-variable cost

The costs that possess both the The costs that possess both the characteristics of fixed and variable may characteristics of fixed and variable may be termed as semi-variable costs or semi-be termed as semi-variable costs or semi-variable over-heads.variable over-heads.For example electricity can be considered For example electricity can be considered as a fixed cost when it is utilised to as a fixed cost when it is utilised to illuminate all the facilities in a plant and it illuminate all the facilities in a plant and it also becomes variable when the level of also becomes variable when the level of operation increases to produce more units. operation increases to produce more units.


What is Angle of IncidenceWhat is Angle of Incidence

The angle at which the sales line cuts the The angle at which the sales line cuts the cost line.Any organisation would want this cost line.Any organisation would want this angle to be wide and large as it indicates angle to be wide and large as it indicates more quantum of profit where all the fixed more quantum of profit where all the fixed over-heads are absorbed.over-heads are absorbed.

A narrrow angle also covers the fixed-A narrrow angle also covers the fixed-over-heads but still the profit margin is low over-heads but still the profit margin is low as compared to the former.as compared to the former.


What is Margin of SafetyWhat is Margin of Safety

When the volume of sales exceeds the When the volume of sales exceeds the break-even point, that area is called the break-even point, that area is called the margin of safety.margin of safety.

It is important that there should be a It is important that there should be a reasonable margin of safety. A low margin reasonable margin of safety. A low margin indicates high fixed over-heads and indicates high fixed over-heads and reduced activity which is not enough to reduced activity which is not enough to absorb the fixed costs and accrue profit.absorb the fixed costs and accrue profit.


P/V Ratio or Profit-Volume RatioP/V Ratio or Profit-Volume Ratio

P/V ratio plays a very important role in all break-even point P/V ratio plays a very important role in all break-even point determination as it indicates the relationship between contribution determination as it indicates the relationship between contribution and turn-over.and turn-over.

P/V ratio= P/V ratio= ContributionContribution SalesSales(or)(or) Sales - Variable costSales - Variable cost SalesSales(or)(or) Sales= Sales= ContributionContribution P/V ratioP/V ratio(or)(or) Contribution= Sales * P/V ratio Contribution= Sales * P/V ratio

This is basically expressed in percentage % This is basically expressed in percentage %


Calculation of BE point Calculation of BE point

Break-even point= Break-even point= Fixed costFixed cost P/V ratioP/V ratioThis formula is derived from the basic formula of break-even point This formula is derived from the basic formula of break-even point

which is:which is:1. 1. Fixed cost*SalesFixed cost*Sales Sales-Variable expenses (or)Sales-Variable expenses (or)2. Fixed costs / 2. Fixed costs / Sales-Variable expensesSales-Variable expenses Sales (or)Sales (or)3. Fixed costs/ P/V ratio (or)3. Fixed costs/ P/V ratio (or)4. 4. Fixed costsFixed costs P/V ratio (or)P/V ratio (or)5. Fixed Cots* 5. Fixed Cots* 1 1 P/V ratioP/V ratio


Break Even GraphBreak Even Graph


Contribution GraphContribution Graph


Profit and LossProfit and Loss


PROBLEMSPROBLEMS1. Find the BEP of production in terms of unit and in terms of value if the price of the product 1. Find the BEP of production in terms of unit and in terms of value if the price of the product

is Rs 250 per unit; variable cost is Rs 150 per unit and the fixed cost is Rs 1,50,000.is Rs 250 per unit; variable cost is Rs 150 per unit and the fixed cost is Rs 1,50,000.SolutionSolution

In terms of unit:In terms of unit:

BEP = FC/(SP – VC)BEP = FC/(SP – VC) = 1,50,000/(250 – 150) =1,500 units= 1,50,000/(250 – 150) =1,500 units

In terms of value:In terms of value:

BEP = FC/MC%BEP = FC/MC%MC% = (SP – VC)/SPMC% = (SP – VC)/SP = Rs (250 – 150)/ 250 = 0.40 = 40%= Rs (250 – 150)/ 250 = 0.40 = 40% = Rs 1,50,000/0.40 = Rs 3,75,000= Rs 1,50,000/0.40 = Rs 3,75,000 2. If the product’s demand is price-inelastic, the firm raises the price of the product from Rs 2. If the product’s demand is price-inelastic, the firm raises the price of the product from Rs

250 to Rs 300 with the same variable cost of Rs 150 and the unchanged fixed cost of Rs 250 to Rs 300 with the same variable cost of Rs 150 and the unchanged fixed cost of Rs 1,50,000. Will the BEP change from that when it remains unchanged?1,50,000. Will the BEP change from that when it remains unchanged?

SolutionSolutionBEP with an increase in SP:BEP with an increase in SP:Rs 1,50,000/(300 – 150) = 1,000 unitsRs 1,50,000/(300 – 150) = 1,000 units

break even analysis- a comprehensive and clear description

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