Submitted by:

Binoo Gupta

Associate professor

PG Department of Commerce and Management

Hans Raj Mahila Maha Vidyalaya, Jalandhar

BREAK EVEN ANALYSIS

A break-even point is that volume of sales or production where there is neither profit nor loss. At this point the contribution equals to fixed cost, i.e.,-

Contribution = Fixed Cost

In marginal costing, variable costs are identified with the production and products and fixed costs are not allocated or apportioned to the products. The contribution from the sale of the products should absorb the fixed cost. When contribution equals fixed cost there is neither profit nor loss. At B.E.P. total cost is exactly equal to revenue and after this point profit begins.

Break Even Analysis

Break-even analysis is a widely used technique to study the CVP (Cost Volume Profit)relationship. It is interpreted in narrow as well as broad sense.

In Narrow sense it means:

• Break-even analysis is concerned with determining break-even point.
• Break-even point is that level of production and sales where there is no profit and no loss. At this point total cost is equal to total sales.

In Broad sense it means:

• Break-even analysis is used to determine probable profit/loss at any given level of production or sales.
• It also helps to determine the amount or volume of sales to earn a desired amount of profit.

Break-even analysis depends on the following variables:

• Selling Price per Unit: The amount of money charged to the customer for each unit of a product or service.
• Total Fixed Costs: The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed.
• Variable Unit Cost: Costs that vary directly with the production of one additional unit.
• Total Variable Cost The product of expected unit sales and variable unit cost, i.e., expected unit sales times the variable unit cost.

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 remains constant and total variable cost varies in direct proportion to the volume of production.

Total fixed cost remains constant.

2. Selling price per unit does not change as volume changes. There is only one product or in the case of multiple products, the sales mix does not change. In other words , when several products are being sold, the sale of various products will always be in some predetermined proportion.

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3. There is synchronization between production and sales. In other words , volume of production equals volume of sales.

4.Productivity per worker does not change.

5.There will be no change in the general price level.

6.Volume of production is the only factor that influences cost.

7. There is a constant demand for the product, it means whenever is produced can be sold out.

8  In the case of multi-product firm, the product mix is stable.

9 It assumes constant technology and no improvement in labour efficiency.

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Break Even Point Calculation

It can be calculated Mathematically as well as graphically.

Graphical Method of computing Break even point

Construction of Break-Even Chart:

1. On the graph the ‘X’ axis (horizontal axis) shows the volume of production and the ‘Y’ axis (Vertical axis) shows the cost and sales. A graph has two sides which are known as “axes”. The horizontal side at the bottom of the graph is the X-axis. The left hand vertical side is the Y-axis. On the Y-axis, costs and revenues are exhibited. On the X-axis one or more of production quantity, capacity in percentage form, sales volumes etc. are shown.

2. Draw both axes on the suitable graph paper on the basis of appropriate scale.

3. Insert production quantity on X-axis and costs and sales revenues on Y-axis.

4. Draw the fixed cost line on the graph. Even at zero production, the fixed costs remain the same. At zero production, the fixed costs will be the loss.

5. The total cost line is drawn above the fixed cost line. For this purpose, the variable cost is added to the fixed cost to arrive at the total cost and drawn at each and every scale of production.

6. Sales revenue line is drawn commencing at zero and finishing at the last point.

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7. Then the sales line cuts the total cost line i.e. sales equals the total cost. This is known as Break-Even Point. If a dotted line is drawn from B.E.P. to X-axis, it indicates B.E.P. (Units) and if it is drawn towards the Y-axis, it indicates B.E.P. (value).

8. The difference between the sales line and total cost line is marked as profit and it is to the right of B.E.P. The angle at which the sales line cuts the total cost line is the angle of incidence.

9. The position to the left of the B.E.P. on the graph indicates the loss which goes up to the total amount of fixed costs which is the maximum loss at the zero production.

10. Then the graph will indicate the B.E.P., profit or loss at different levels of output, margin of safety, contribution and the relationship between the marginal cost, fixed cost and total cost.

Forms of Break-Even Chart:

There are different ways of constructing a break-even chart. Charts which depict cost- volume-profit data are visual aids which serve to depict the effect of changes in cost, volume and profit. Like other charts, they impress effectively and tell their stories at a glance.

There are numerous ways in which break-even charts are prepared depending upon the purpose which they are meant to serve and the details which they are required to exhibit.

The forms of break-even charts, which are of importance, have been explained next:

(a) Simple Break-Even Chart:

This is a traditional break-even chart. This chart is used to predict profit or loss to be obtained from a certain level of sales or production. It is a combination of fixed cost line, variable cost line and the sales line.

(b) Contribution Break Even Chart:

In the case of a simple break even chart, the variable cost line is shown above the fixed cost line. Sometimes fixed costs can be shown above the variable costs. In such a case the chart is known as contribution break even chart. The speciality of this chart is that contribution is indicated clearly in the chart by way of difference between variable cost line and sales line.

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(c) Analysis (or Detailed) Break-Even Chart:

The analysis break-even chart analyses the variable costs under different elements such as direct material, direct labour, factory overhead, selling and distribution overhead etc.

In addition, the profit is also sub-divided into various appropriations such as debenture interest, income tax, preference dividends, equity dividends and reserves. All these are plotted on the conventional B.E.P. graph by way of analysis.

(d) Control Break-Even Chart:

Break-even charts may be prepared in conjunction with standard costing and budgetary control system. Budgeted fixed costs, budgeted variable cost and budgeted sales are also plotted, in addition to the actual fixed costs, actual variable costs and actual sales.

This graph is useful for comparing budgeted and actual profits, B.E.P. and sales. It facilitates to study the significant deviations, more particularly, the profit variance.

(e) Profit Volume Chart:

It is a simplified and improved form of break-even graph. It is a pictorial representation of cost-volume-profit relationship. All basic data, required for the BE chart, are required for the construction of the profit volume graph. In this chart, the horizontal axis represents the sales volume and the vertical axis shows profit or loss.

The vertical slope line above the horizontal line represents the profit and below the horizontal line shows loss. The diagonal line presents the total marginal contribution of the business.

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(f) Cash Break-Even Chart:

It also follows the conventional form of graph. The expenses are divided into two viz. cash expenses and non-cash expenses such as depreciation. The cash fixed cost and the total cash cost lines i.e. excluding depreciation etc. are drawn along with the sales line. The meeting point of the sales line and the total cash cost line is the cash break-even point.

A model of Cash flow break-even chart is given below:

Angle of Incidence:

The angle, to the right of B.E.P., is formed, by intersecting the sales line and the total cost line. It indicates the profit-earning capacity. The angle may be large or small.

A greater angle of incidence means that the profits are made at high rate and vice versa. Generally, a large or wider angle of incidence together with a high margin of safety indicates the most favourable situations.

Advantages of Break-Even Analysis and Chart:

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1. Total cost, variable cost and fixed cost can be determined.

2. B.E. output or sales value can be determined.

3. Cost, volume and profit relationships can be studied, and they are very useful for managerial decision-making.

4. Inter-firm comparison is possible.

5. It is useful for forecasting plans and profits.

6. The best products mix can be selected.

7. Total profits can be calculated.

8. Profitability of different levels of activity, various products or profit, i.e., plans can be known.

9. It is helpful for cost control.

10. It helps in determining the costs and revenue at different levels of output.

11. It helps in determining the most profitable sales mix.

12. It helps in determining comparative profitability of each product line

13. It helps in determining the sales volume to earn a desired profit or return on capital employed

14 It helps in determining cash requirements at different levels of operation with the help of cash break-even chart.

15. It studies the effect of change in selling price or of price differentiation in different markets. E.g., home market and foreign market.

16. It studies the impact of increase or decrease in in fixed and variable costs on profits.

17It studies the effect on profits and breakeven points of high proportion of variable costs with low fixed cost and vice- versa.

18It helps the management decision making e.g., in make or buy decisions, discontinuance of a product line, acceptance of special job. Etc.

 19. It offers suggestions for shift in sales unit.

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20Break-even analysis helps the management accountant in forecasting the profit fairly and accurately.

21 It helps in preparing up flexible budgets,

22 It helps in formulating price policy by projecting the effect which different price structures will have on cost and profit.

23 It also assist in performance evaluation for the purpose of management control.

24 It helps in determining the overhead cost to be charged at various levels of production since, overhead rates are generally predetermined on the basis of selected volume of production.

25 It can cope with changing circumstances. e.g. the following changes in the business environment can be shown

Numerical Example:

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ABC ltd. produces goods at a variable cost of Rs.12 per unit, and the same is sold at Rs.20 per unit. Fixed cost incurred by a company for a period stands at Rs.40,000. Calculate the number of products ABC Ltd. needs to manufacture to attain a profit target of Rs.10,000. 

Dear students solve and show attempt in class

Limitations of Break-Even Analysis

1. The assumption that all cost can be clearly separated into fixed and variable components is not possible to achieve accurately in practice, there by resulting in inaccurate break-even analysis.
2. The assumption that variable cost per unit remains constant and that it gives a straight line chart is also not always true. In practice, many of the variable costs do not observe this tendency. Most of the variable costs, no doubt , move in sympathy with the volume of production but not necessarily in direct proportion to the volume.
3. The assumption that only one product is being produced or that product mix will remain unchanged is also not found in practice. The sales of various products manufactured is not always in predetermined proportion.

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4. It is assumed that production and sales are synchronized. This is not always so. Sales may fall short of production or may be capable of increase too much production only by effecting a reduction in selling prices.

5. The break-even analysis completely ignores the consideration of capital employed which may be an important factor in the study of profit analysis.

6 The assumption regarding selling prices remaining unchanged as volume changes is also not true. In practice, selling prices do not remain fixed and change prices affects demand.

7 Similarly, the assumption that fixed and cost remains constant is also unrealistic. Fixed costs are constant only within a limited range of output and tend to increase by a sudden jump when additional plant and machinery is introduced.

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Comparison

Ways to reduce

Break Even Point

1. Cost Analysis: The total cost of a product can be decreased by eliminating the unwanted fixed and variable costs, which ultimately increases the profitability and reduces the break-even point.
2. Price Analysis: Keeping control over the price of the products by reducing discounts and other coupons is another means since it accelerates the break-even point.
3. Margin Analysis: Another method is monitoring the profit margin. Thus, taking essential steps to boost the sales of those products which have a high margin to minimize the break-even point.

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4.Technology Analysis: Break-even point can also be reduced by implementing the latest technology in the business, which increases an organization’s productivity and performance at a minimal cost.

5. Outsourcing: One of the most effective ways is to reduce fixed cost by outsourcing a product or service which was earlier being produced by the company itself. This will convert such fixed value into a variable cost, charged per unit.