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Different business proposals are evaluated in terms of their costs and revenues. To know what costs are to be examined, it is necessary to understand what cost is and how to analyze the cost.

Cost refers to expenditure incurred to produce a product or service.

Cost of production normally includes cost of materials, labor, and other overheads. This is known as total cost.

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Total cost = fixed cost + variable cost + semi variable cost.

Total cost is compared with total revenue. The difference between total cost & total revenue is termed as profit.

TR-TC = PROFIT

Understanding the meaning of various cost concepts is essential for clear business thinking.

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TYPES OF COSTS

Fixed cost
Variable cost
Marginal cost
Opportunity cost
Explicit cost
Implicit cost

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Fixed costs remain fixed in the short run. Whether the production is taken up or not we have to incur certain expenses such as rent for factory & office buildings, insurance, telephone, electricity and so on which come under fixed costs.

Variable costs vary with the volume of production. They comprises cost of raw materials, wages and so on. These costs are incurred only when there is production. The more the production the more will be the variable cost and vice versa.

FIXED COSTS:

VARIABLE COSTS:

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Marginal cost refers to additional cost incurred for manufacturing an additional unit of product. Marginal cost in economic theory is useful in matters relating to allocation of resources, product pricing decisions, make or buy decisions and so on.

Opportunity cost refers to cost of next best alternative foregone. It refers to earnings/profits that are foregone from alternative ventures by using given limited facilities for a particular purpose.
If there are no alternatives there will be no opportunity cost.

MARGINAL COSTS:

OPPORTUNITY COSTS:

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Opportunity cost is said to exist when the resources are scarce and there are alternative uses for the resources. They record only the sacrificed alternative so Opportunity costs are not recorded in the books of accounts.

Ex: The cost of getting college education is not merely you spend on college fee & books. It also includes the earnings you have foregone throughout the year by not taking up a full time job.

OPPORTUNITY COSTS (contd.):

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Explicit costs are also called as out of pocket costs. They involve payment of cash. Rent for the landlord, wages for the labor, taxes & duties paid and so on are examples of explicit costs.
Explicit costs are also called as out of pocket costs because they are incurred in reality.

Implicit costs are also called as imputed costs or non cash costs or notional cost. They don't involve payment of cash as they are not actually incurred. They would have been incurred had the owner not been in the possession of facilities.
Interest on own capital, rent on own premises, savings in terms of salary due to own supervision are examples of implicit cost.

EXPLICIT COSTS:

IMPLICIT COSTS:

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BREAKEVEN ANALYSIS

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INTRODUCTION TO BREAKEVEN ANALYSIS

Break even analysis refers to analysis (study) of Break Even Point (BEP). BEP is defined as no profit or no loss point. (BEP is the point at which total revenue is equal to total cost)

The term BEA is interpreted in two senses, In its narrow sense, it is concerned with finding out BEP. In its broad sense, it determines the probable profit at any level of production.

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BEP denotes minimum volume of production to be undertaken to avoid losses.
It points out the minimum quantity to be produced in order to get profit.
BEP is a technique for profit planning & control.
Break Even Analysis is defined as analysis of Costs & their possible impact on Profits & Volumes of the firm, hence it is also called as CVP analysis.
A firm is said to attain the BEP when its Total Revenue equals to Total Cost (TR =TC).

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�Assumptions underlying Break Even Analysis�

All costs are classified into two – fixed and variable.

Selling price per unit remains constant in spite of competition or change in the volume of production.

There will be no change in operating efficiency.

Volume of sales and volume of production are equal. Hence there is no unsold stock (closing stock).

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Determination of Break Even Point

Break Even Point can be determined by two methods:

Graphical Representation Method &
Algebraic Method

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Graphical Representation Method

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Explanation

The total variable cost (TVC) line is drawn first, variable cost varies proportionately with the volume of production.

Total Fixed cost(TFC) line is horizontal straight line, it is parallel to X axis since total fixed cost remains constant in the short run.

The total cost (TC) line is derived by adding, the TVC & TFC. The total cost line is parallel to total variable cost line.

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The total revenue (TR) line starts from origin & increases along with the volume of sales.

The total revenue line intersects total cost line at point BEP. (BEP = TC = TR)

The zone below BEP point is loss zone & zone above BEP point is profit zone.

The point at which total cost line & total revenue line intersects is called Break – Even Point (BEP).

At this point there exists neither profit nor loss

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The angle formed at BEP, i.e., the point of intersection of total cost & total revenue is called ANGLE OF INCIDENCE (AOI).

The larger the angle of incidence , the higher is the quantum of profit.

Sales over & above break even sales are termed as MARGIN OF SAFETY (MOS).

MOS = Total sales – Break even sales

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The lower the BEP the better it is, a firm can survive even if it is operating at a lower level of activity.

The larger the AOI the greater is the benefit, angle of incidence represents the difference between total revenue & total cost.

The larger the MOS the better it is for the firm, it has greater capacity to with stand Recessionary phases.

Conclusion a high MOS, large AOI & low BEP denotes the most favorable position to the firm.

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Significance of BEA

BEP denotes minimum volume of production to be under taken to avoid losses, in other words it points out how much minimum is to be sold to get the profits.
It helps in ascertaining the profit on a particular level of sales volume
It also helps in estimating sales required, to earn a particular desired level of profit.
It is useful tool in comparing the efficiency of different firms.
It helps in “Make or Buy decisions” for a given component or spare part.
It helps in assessing the impact of changes in fixed cost, variable cost & selling price on profits during a period of time. (CVP analysis)

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Limitations of BEA

BEA is based on Fixed cost concept, & hence holds good only in the short run.
If business conditions are Volatile, BEP cannot give stable results.
All costs cannot be Classified into Fixed & Variable costs, some times we may also have Semi variable costs.
In case of Multi Product Firm, a single chart cannot be of any use, series of charts have to be made use of, which is a complex process.

The above limitations do not deter the utility of Break Even Analysis. Even today most of the business proposals are evaluated on the concept of BEP.

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Application of BEA

The following are some of the areas of applications of Break Even Analysis

Make or Buy decisions
Drop or Add decisions
Choosing a product mix when there is a limiting factor

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ALGEBRAIC METHOD

The following formulas are used to determine Break Even Point.

SP = FC + VC + profit

SP – VC = FC + Profit

= Contribution

So, Contribution per Unit = SP p.u – VC p.u

BREAK EVEN POINT = FC (in units)

Contribution p.u

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CONTRIBUTION MARGIN

Contribution Margin is the difference between receipts and variable expenses.

Ex: If a product is sold at Rs.10 per unit and its variable expenses are Rs.4.

This implies that each unit of the product recovers Rs.6 over and above its variable expenses of Rs.4.Thus, Rs.6 is contribution to the recovery of fixed expenses or profit.

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ALGEBRAIC METHOD

The following formulas are used to determine Break Even Point.

SP = FC + VC + profit

SP – VC = FC + Profit

= Contribution

So, Contribution per Unit = SP p.u – VC p.u

BREAK EVEN POINT = FC (in units)

Contribution p.u

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DETERMINATION OF BREAK EVEN POINT

BREAK EVEN POINT = FC (in value)

Contribution margin

ratio

Where, CMR = CM p. u

SP p. u

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PROBLEMS ON BEP

If sales are 10,000 units and selling price is Rs.20 per unit, variable cost Rs.10 per unit and fixed cost is Rs.80000, find out BEP in units and in sales revenue. What is profit earned? What should be the sales for earning a profit of Rs.60,000?

Determine MOS using above information.

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2. The information about Raj & Co., are given below:

i) Profit-Volume Ratio 20%

ii) Fixed Cost Rs.36,000

iii) Selling price per unit Rs.150

Calculate:

a) BEP (in Rs.)

b) BEP (in units)

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3. Analyze the following information

Sales are Rs. 90,000 producing a profit of Rs. 2900 in period-I

Sales are Rs. 1, 10,000 producing a profit of Rs. 6000/- in period-II

Determine BEP and Fixed Expenses.

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4 .Calculate the following parameters using given data.

i) p/v ratio

ii) Break even sales volume

iii) Margin of safety

iv) Profit

Given data: Sales Rs. 4000, Cost Rs. 2000, Fixed Cost Rs. 1600.

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5. If Selling Price Per Unit Rs.12, Variable Cost Per Unit Rs.8, Fixed Cost Rs.40000

Find out

(a) Break Even sales units and value

(b) profit when sales are Rs.300000

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6. From the following information you are required to calculate:

i. P/V Ratio

ii. Break-Even Sales in RS.

iii. Margin of Safety and

iv. Profit.

Sales Rs.4000

Variable Cost Rs.2000

Fixed Cost Rs.1600

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7. A company prepares a budget to produce 3 lakh units, with fixed costs as Rs.15 lakhs and average variable cost of Rs.10 each. The selling price is to yield 20% profit on cost. you are required to calculate

(a) P/V ratio.

(b) Break even point.

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What is a Market?

Market is defined as a place or point at which buyers and sellers negotiate their exchange of well-defined products or services.

Market is any area over which buyers and sellers are in close touch with one another, either directly or through dealers, that the price obtainable in one part of the market affects the prices paid in other parts. - Benham

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MARKET CLASSIFICATION

Classification on the basis of area covered or location

Local market
National market
International market

Classification on the basis of time

Very short period market
Short period market
Long period market

Classification on the basis of degree of competition

Perfect Market
Imperfect Market

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PERFECT COMPETITION

A market structure in which all firms in an industry are price takers and in which there is freedom of entry into and exit from the industry is called Perfect Competition.

The market with perfect competition condition is known as perfect market.

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FEATURES OF PERFECT MARKET

Large number of buyers and sellers
Price taker
Homogeneous products
The firms are free to enter or leave the industry
Perfect Mobility of factors of production
Perfect knowledge
No publicity cost
Uniform prices
AR curve is parallel to X axis

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IMPERFECT COMPETITION

A market structure in which all the firms in the industry are price makers and in which there lies restrictions to enter in to the industry is called Imperfect Competition.

The market with imperfect competition condition is known as imperfect market

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FEATURES OF IMPERFECT MARKET

Sellers and buyers
Nature of commodity
No uniform prices (price discrimination)
Entry is restricted
No perfect knowledge
Price maker
Publicity cost
AR curve is downward sloping [MR curve is always below AR curve]

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Imperfect market take several forms

Monopoly
Duopoly
Oligopoly
Monopolistic competition

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MONOPOLY

A pure monopoly exists if one and only one firm produces and sells a particular commodity in the market.

The single firm producing the product is itself both the firm and the industry.

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FEATURES

Only one firm sells the commodity having no rivals or direct competition
Price Maker
Indirect rivalry may exist in the form of

i) Existence of substitute products

ii) Competing for the consumer’s rupee

No other seller can enter the market, else monopoly would cease to exist.
The product is distinct i.e., inelastic demand

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CAUSES OF MONOPOLY

Patent Rights give legal monopoly
Govt. policies such as granting licenses
Ownership and control of some strategic raw materials.
Exclusive knowledge of technology by the firm.
Size of the market may accommodate only a single firm
Limit pricing policy adopted to prevent new entrants.

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MONOPOLISTIC COMPETITION

Monopolistic Competition refers to a situation where there are many sellers of a differentiated product.

There is competition which is not perfect, between many firms making very similar products which are close but not perfect substitutes.

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