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Break Even Analysis

# Break Even Analysis

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12/19/2012

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BREAK EVEN ANALYSIS
Break even analysis is the analysis of the relationship of cost, volume ,profit revenue, volume of sale for a particular product of a company.Break even analysis is usually done with the help of a break even chart. Break even chart is agraphical representation of various components like Fixed cost, Variable cost, Total cost, Quantityof production/sales, sales revenue, profit/lose and margin of safety. The chart has Quantity of  production/sales on X axis and cost/sales revenue in Rupees on Y axis. It is assumed that thequantities of production and sales are same
COMPONENTS OF BREAK EVEN CHART
1.FIXED COST
Fixed cost is the costs that remain constant irrespective of Quantity of production . It includes
Salary
Rent and other establishment charges
DepreciationFixed cost is represented by a line parallel to X axis.
2.VARIABLE COST
Variable cost is the sum of costs that vary directly with the volume of production / sales. It includes
Direct labor costs consisting of wages and other benefit paid to direct workmen
Direct material cost

Other semi-variable costs like fund, electricity, maintenance, transport etcVariable cost at any quantity of production/sale = variable cost per piece X QuantityVariable cost is represented by inclined line starting from (0,0)
3.TOTAL COST
Total cost of any point represents the sum of fixed cost and variable cost at that quantity.Total cost = Fixed cost + variable costTotal cost is represented by an inclined line starting from cost in Y axis (0.FC)
4.SALES REVENUE
Sales revenue is represented by an inclined line starting from (0,0)
ANALYSIS OF BREAK EVEN CHART
1BREAK EVEN POINT (BEP)
Break even point is the point in BE chart where Sales Revenue = Total cost. It is represented a point where the Total cost line crossed the Sales Revenue line. At BEP, there is no loss and no profit.
2BREAK EVEN QUANTITY (BEQ)
The quantity of production/sales at BEP is termed as Break even Quantity
3BREAK EVEN COST/REVENUE
The sales revenue or total cost at BEP is termed as BE Revenue or BE cost
4PROFIT
Profit at a particular Quantity isProfit = Sales revenue – Total cost for that Quantity. It represents the area between the salesrevenue line and total cost line after BEP in the BE chart
5LOSS
If sales revenue is less than total cost, the product is making a lossLoss= Total cost – sales revenue for that quantityIt is represented by the area between the two lines before BEP in the BE chart
6ANGLE OF INCIDENCE
It is the angle between sales revenue line and the total cost line. Large angle indicate higher rate of  profit, means higher profits for small increase in sales.
7MARGIN OF SAFETYQUANTITY
Margin of safety (Quantity) = Present Quantity of Sale – BE QuantityThe importance of margin of safety is that it shows graphically the vulnerability of company’s profit due to changes in Quantity of Production/sale. If the distance or difference is large, even if there is a serious drop in production/sales, the profit will not be affected much. If the distance isshort, a small drop in production /sale will lead to loss for the company. Margin of safety can beexpressed in absolute values or as %age of the current level of production/sale.
MARGIN OF SAFETY (Rs)

= Present sales value –BE Revenueexample= total sale – BEP Sale=sale Rs 5,00,000, BEP sale = 3,00,000Margin of Safety 500000-300000 = 200000It can be represented as 40% (200000/500000 x 100 )
CONTRIBUTION
Contribution is the difference between the sale price / unit and the marginal cost (variable cost) per unitSuppose the selling price is Rs 10/ unitVariable cost is Rs 7/ unitFixed cost Rs 30,000Contribution is Rs 3
1Calculation of profit of different sales volume2Calculation of sales volume to produce desired profit.3Calculation of selling price per unit for a particular break even point4Calculation of sales volume required to meet proposed expenditure5Determination of sales required to offset price reduction6Measurement of effect of changes in profit factors7Choosing the most profitable alternatives8Determining the optimum sales mix9Deciding on changes in capacity
LIMITATIONS OF BE ANALYSIS
The break even analysis is based on a number of assumptions which are rarely found in reallife. Hence its managerial utility becomes limited. Its main limitations are as follows1Both cost and revenue should be taken into account to determine the break even point.The one without the other has no meaning. But this analysis pre suppose that prices do notchange while in actual life, price do changes as a result of several factors eg-change indemand, fashion, styles etc2It assumes that all costs can be divided into fixed and variable costs, that they vary inlinear fashion and that the principle of cost variability applies to them. All theseassumptions do not hold true3This analysis ignores the time lag between production and sales. The production quantitymay be kept constant, but the sales are bound to vary from period to period. This featureof sales reduces the significance of BE analysis as a management guide.4Factors like plant size, technology and methodology of production have to be keptconstant in order to draw an effective break even chart. But it is not found in actual life.5The analysis does not take into account the capital employed in the production and its costwhich is an important consideration in profitability decisions.

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