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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 a

graphical representation of various components like Fixed cost, Variable cost, Total cost, Quantity

of 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 the

quantities of production and sales are same

1. FIXED COST

Fixed cost is the costs that remain constant irrespective of Quantity of production . It includes

• Salary

• Administrative expenses

• Rent and other establishment charges

• Depreciation

Fixed 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 etc

Variable cost at any quantity of production/sale = variable cost per piece X Quantity

Variable 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 cost

Total 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)

1 BREAK 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.

The quantity of production/sales at BEP is termed as Break even Quantity

The sales revenue or total cost at BEP is termed as BE Revenue or BE cost

4 PROFIT

Profit at a particular Quantity is

Profit = Sales revenue – Total cost for that Quantity. It represents the area between the sales

revenue line and total cost line after BEP in the BE chart

5 LOSS

If sales revenue is less than total cost, the product is making a loss

It is represented by the area between the two lines before BEP in the BE chart

6 ANGLE 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.

7 MARGIN OF SAFETY

QUANTITY

Margin of safety (Quantity) = Present Quantity of Sale – BE Quantity

The 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 is

short, a small drop in production /sale will lead to loss for the company. Margin of safety can be

expressed in absolute values or as %age of the current level of production/sale.

= Present sales value –BE Revenue

example

= total sale – BEP Sale

=sale Rs 5,00,000, BEP sale = 3,00,000

Margin of Safety 500000-300000 = 200000

It 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

unit

Suppose the selling price is Rs 10/ unit

Variable cost is Rs 7/ unit

Fixed cost Rs 30,000

Contribution is Rs 3

1 Calculation of profit of different sales volume

2 Calculation of sales volume to produce desired profit.

3 Calculation of selling price per unit for a particular break even point

4 Calculation of sales volume required to meet proposed expenditure

5 Determination of sales required to offset price reduction

6 Measurement of effect of changes in profit factors

7 Choosing the most profitable alternatives

8 Determining the optimum sales mix

9 Deciding on changes in capacity

LIMITATIONS OF BE ANALYSIS

The break even analysis is based on a number of assumptions which are rarely found in real

life. Hence its managerial utility becomes limited. Its main limitations are as follows

1 Both 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 not

change while in actual life, price do changes as a result of several factors eg-change in

demand, fashion, styles etc

2 It assumes that all costs can be divided into fixed and variable costs, that they vary in

linear fashion and that the principle of cost variability applies to them. All these

assumptions do not hold true

3 This analysis ignores the time lag between production and sales. The production quantity

may be kept constant, but the sales are bound to vary from period to period. This feature

of sales reduces the significance of BE analysis as a management guide.

4 Factors like plant size, technology and methodology of production have to be kept

constant in order to draw an effective break even chart. But it is not found in actual life.

5 The analysis does not take into account the capital employed in the production and its cost

which is an important consideration in profitability decisions.

MATHEMATICAL CALCULATION OF BEP

Calculate BEP from the following

information

Total cost = Rs 55000

Fixed cost = Rs 20000

Sale(7000 units) = 70000

VC=55000-20000 = 35000 OR

Rs 5

Contribution per unit =

10-5 = Rs 5

BEP in Units = 20000/5=40000 u

20000+20000 = Rs 40000

Profit Contribution-fixed cost

Fixed cost Contribution – profit

contribution Fixed cost+profit

PV Ratio Contribution per unit

(Profi volume ratio) Selling price per unit

Contribution x 100

sales

BEP (output) BEP (Rs)

Fixed cost Fixed cost x selling price/unit

Contribution per unit Contribution / unit

or

Fixed cost x Total sales

Total contribution

or

Total fixed cost

1- variable cost per unit

selling price per unit

or

fixed cost

P/V Ratio

sewing m/c has or

capacity to produce 240x250 = Rs60000/= 12000 x 125000/25000=

500 m/cs per Rs 60,000/=

annum. The Or

variable cost of 12000

each m/c is Rs 200 1- 200/250=12000

and each m/c is sold 1/5

for Rs 250. Fixed = Rs 60,000/=

expense are Rs or

1200 pm. Calculate 12000/20% = Rs60,000/=

the BEP for output

and sales. NE – PV RATIO=

Cntribution x 100

Sales

Total sale= Rs 1,50,000

= total current Variable cost = Rs 75,000

sales-BE Sales Fixed cost = 50,000

Margin of safety=

Formula BE Sales = fixed cost

Net profit P/V Ratio

P/V Ratio = 50,000/50%

NB- margin of = Rs 1,00,000

safety can be

expressed as net profit = contribution

percentage of sales minus fixed cost

Margin of safety x 100 = 75000-50000=25000

Total sales margin of safety=

Or Rs 1,50,000-1,00,000

Sales-BE sales x100

Sales

Rs 50,000

Or

= net profit

P/V Ratio =

25000/50%= Rs 5000o/=

Calculation of Sales in units

sales to get desired FC+desired profit

profit P/V Ratio

Sales in Rs

FC+desired profit

P/V Ratio

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