You are on page 1of 6

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 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

COMPONENTS OF BREAK EVEN CHART


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)

ANALYSIS OF BREAK EVEN CHART


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.

2 BREAK EVEN QUANTITY (BEQ)


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

3 BREAK EVEN COST/REVENUE


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

Loss= Total cost – sales revenue for that quantity


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.

MARGIN OF SAFETY (Rs)


= 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

ADVANTAGES OF BREAK EVEN ANALYSIS


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

Contribution Selling price-variable cost An example


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

BEP in value= FC+VC


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

A factory making 12000/50=240 m/cs 1200x250/50=Rs 60000/=


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

25000/125000 x 100 = 20%

Margin of Safety Example


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