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Benefits and Limitations of Break-Even

Analysis |Financial Management


by Smriti Chand Financial Management

Some of the major benefits and limitations of break-even analysis in


financial management are as follows:
Break-even analysis is a very important and useful tool of financial management
and control. The simplicity of these charts is one of their great values.
As they are easy to understand, they constitute a helpful mechanism for showing
the top management the problems inherent in cost-volume- profit relationships.
They are extremely useful in planning devices.
Benefits:
The following are the benefits out of break-even analysis:
1. Make or buy decision:
The C-V-P analysis assists in making a choice between two courses of action to
make versus to buy. If the variable cost is less than the price that has to be paid to
an outside supplier, it may be better to manufacture than to buy.
2. Production planning;
The C-V-P analysis helps in planning the production of items giving maximum
contribution towards profit and fixed costs.
3. Cost control:
As a cost control device, the C-V-P analysis can be used to detect insidious
upward creep of costs that might otherwise go unnoticed.
4. Financial structure:
Break-even analysis provides an understanding of the behaviour of profits in
relation to output. This understanding is significant in planning the financial
structure of a company.
5. Conditions of uncertainty:
When some reasonable basis for subjective extrapolation is available, the breakeven analysis provides the financial management with information helpful in its
decision-making activities.

Limitations:
The following limitations of break-even analysis have to be kept in
mind while making use of this tool:
1. Many costs and their components do not fall into neatly compartmentalized
fixed or variable cost categories as they possess the characteristics of both types.
2. If company sells several products, the financial manager has to prepare and
evaluate a number of profit-graphs covering integrated segments of independent
activities.
3. A break-even chart represents a short-run static relationship of costs and
output and become obsolete very quickly.
4. The relations indicated in the break-even chart do not help for all levels of
operations. Costs tend to be higher than shown on the static break-even chart
when the plants operation approaches 100 percent of its capacity.
5. The frequent changes happening in the selling price of the product affect the
reliability of the break even analysis.
6. The cost of securing funds to expand is disregarded in break-even chart.
In spite of the above mentioned limitations, the breakeven analysis has high place
in financial management.