Break-Even and Cost-VolumeProfit Analysis

Chapter 8

Break-even Analysis

Determines at what level cost and

revenue are in equilibrium
Break-even point

Obtained directly by mathematical

calculations
Usually presented in graphic form known
as break-even chart

Determining the Break-Even Point

Each expense must be analyzed to

determine its fixed and variable portions
Semi-variable expenses must be separated
into their fixed and variable components
Fixed portion is stated as a total figure
Variable portion is stated as a rate or
percentage

Determining the Break-Even Point

Break-even analysis may be based on

Historical data
Future sales and costs

Determining the Break-Even Point

Contribution margin ratio (C/M ratio)

Also known as marginal income ratio or Profit-volume

ratio
Contribution of each dollar towards covering fixed costs
and making a profit

Contribution margin ratio = 1 (Variable costs/Sales)

OR
Contribution margin ratio =
unit contribution margin/unit sales price
Contribution margin= sales variable costs

Example

The ABC Lodge has sales of $4500,000.

The fixed expense was $1,200,000 and the
variable expense totaled $1,800,000.

Contribution margin ratio

Contribution margin

Income Statement

Sales
Less variable expenses
Total contribution margin
Less fixed expenses
Profit

xxx
xxx
xxx
xxx
xxx

Determining the Break-Even Point

Break-even
=
sales volume ($)

Break-even
=
sales volume ($)

Fixed costs
Contribution margin ratio

Fixed costs
1 (Variable costs/Sales)

Determining the Break-Even Point

Break-even
sales in units

Fixed costs
Contribution margin/unit

Break-even
sales in units

Break-even sales in dollars

Unit sales price

Example

The ABC Lodge has sales of $4500,000.

The fixed expense was $1,200,000 and the
variable expense totaled $1,800,000.

Break even point in dollars

Equation Approach

Profit=
Sales revenue-variable expenses-fixed expenses

Profit=

(Unit sales price)*(sales volume)- (unit variable

expenses)*(sales volume)-(Fixed expenses)

Determining the Break-Even Point

Break-even capacity %age =
Break-even sales in dollars
Normal sales volume in dollars
Margin of Safety ratio =
Sales Break-even sales
Sales
Profit % = CM ratio x Margin of safety ratio

Break even Chart

Break even Chart

Changes in Fixed expenses

Original estimate
Fixed utilities expenses
$1,400
Total Fixed expenses
48,000

new estimate
$2,600
49,200

Breakeven calculation
48,000
(FC/unit contribution margin) $6

49,200
$6

Break even point(units)

Break even point (dollars)

8,200 units
$131,200

8,000units
$128,000

Break even Chart

Change in unit variable expenses

Increase in unit variable expenses will cause

a decrease in unit contribution margin.

Break even will now be achieved at a higher

output level.

Break even Chart

Change in sales price

Increase in sales price will cause an increase in unit

contribution margin.

Break even will now be achieved at a lower output

level.

However, careful analysis by the management is

required as the increase in sales price might also
cause a decline in output sold.

Profit-Volume Analysis

Target Net Profit

We can use break-even analysis to find the

sales required to reach a target level of
profit.

Number of sales units required to earn

target profit:
= Fixed expenses+ Target net profit
Unit contribution margin

Example

Calculate the number of units the company

needs to sell in order to realize a Profit of
$500,000?
Given:
Fixed costs= $100,000
Sale price= $10
Variable cost per unit= $5

Constructing a Break-even Chart

Example:

Fixed costs = $1,600,000

Sales = $5,000,000
Sales/unit = $4
Variable cost/unit = $2.4/unit

Construct Break-even chart