UNIT 3 INDUSTRIAL MAINTENANCE

3.1 Maintenance:

“Maintenance is a routine and recurring activity of keeping a particular machine,

equipment or facility at its normal operating condition so that it can deliver its expected
performance or service without causing any loss of time on account of accidental damage
or breakdown”.

Once equipment is designed, fabricated and installed, the operational availability of the same is
looked after by the maintenance requirement. The idea of maintenance is very old and was
introduced along with inception of the machine. In the early days, a machine was used as long as
it worked. When it stopped working, it was either repaired/serviced or discarded.

The high cost sophisticated machines need to be properly maintained/serviced during their entire
life cycle for maximizing their availability. The development of mechanization and automation
of production systems and associated equipment, with the accompanying development of
ancillary services and safety requirements, has made it mandatory for engineers to think about
proper maintenance of equipment.

Maintenance is a function to keep the equipment/machine condition by replacing or repairing

some of the components of the machine. The maintenance concept is an outline plan of how the
maintenance function will be performed.

Based on the feedback obtained from the users and the history of the equipment, detailed
procedures are drawn to concretize the maintenance concept. The procedures developed thus are
collectively called the maintenance plan. The development of such a maintenance plan is one of
the most important requirements of the maintenance program that requires interaction between
the user and the manufacturer. With this information, the manufacturer will be in position to
rearrange the design as per user’s maintenance requirements.

Maintenance function also involves looking after the safety aspects of certain equipment where
the failure of component may cause a major accident. For example, a poorly maintained pressure
vessel such as steam boiler may cause a serious accident.

3.11 Need of Maintenance

One of the factors that can ensure availability of installed facilities for efficient use is an
effective and efficient maintenance engineering system. Gone are the days when maintenance
was not given adequate attention. For any company with mechanized and automated systems,
more attention is now given to maintenance function. Therefore, the need for maintenance
increases with technological advancement in production facilities. Other factors which seem to
emphasize the need for effective maintenance system are:
 (i) strong competition
(ii) tight production schedules
(iii) increased machine utilization
(iv) increased production level

Inadequate or lack of effective and efficient maintenance system especially in a manufacturing

enterprise gives rise to several undesirable consequences. These consequences include:

(i) Excessive machine breakdown

(ii) Frequent emergency maintenance work
(iii) Shortened life-span of the facility
(iv) Poor use of maintenance staff
(v) Loss in production output
(vi) Inability to meet delivery dates
(vii) Excessive overtime
(viii) Loss of lives
These factors may contribute to high costs of production and consequently loss in profitability.

3.12 Function of Maintenance Department

The function of maintenance department can be divided into primary and secondary: The
primary functions of maintenance are:

(i) Maintenance of existing machines and equipment

(ii) Maintenance of existing buildings
(iii) Inspection and lubrication of machine and equipment
(iv) Generation and distribution of utilities e.g. water, electricity etc.
(v) Installation of new machines and equipment
(vi) Modifications of existing machines, equipment and buildings

The secondary functions include the following:

(i) Sanitation
(ii) Disposal of used items
(iii) Storekeeping
(iv) Fire protection
(v) Janitorial service ( Periodic cleanliness)
3.2 Types of Maintenance

Figure 3.1 Diagrammatic representations of types of maintenance

3.21: Breakdown Maintenance:

Breakdown maintenance is referred to by many different names: reactive maintenance, repair, fix
when-fail, and run-to-failure (RTF) maintenance etc. When applying this maintenance strategy, a
piece of equipment receives maintenance (e.g., repair or replacement) only when the
deterioration of the equipment’s condition causes a functional failure. The strategy of breakdown
maintenance assumes that failure is equally likely to occur in any part, component, or system.
Thus, this assumption precludes identifying a specific group of repair parts as being more
necessary or desirable than others. The major downside of breakdown maintenance is
unexpected and unscheduled equipment downtime. If a piece of equipment fails and repair parts
are not available, delays occur while the parts are ordered and delivered. If these parts are
urgently required, a premium for expedited delivery must be paid. If the failed part is no longer
manufactured or stocked, more drastic and expensive actions are required to restore equipment
function. Cannibalization of like equipment or rapid prototyping technology may satisfy a
temporary need but at substantial cost. Also, there is no ability to influence when failures occur
because no (or minimal) action is taken to control or prevent them. When this is the sole type of
maintenance practiced, both labor and materials are used inefficiently. Labor resources are
thrown at whatever breakdown is most pressing. In the event that several breakdowns occur
simultaneously, it is necessary to practice a kind of maintenance in an attempt to bring all the
breakdowns under control. Maintenance labor is used to “stabilize” (but not necessarily fix) the
most urgent repair situation, then it is moved on to the next most urgent situation, etc.
Replacement parts must be constantly stocked at high levels, since their use cannot be
anticipated. This incurs high carrying charges and is not an efficient way to run a storeroom. A
purely reactive maintenance program ignores the many opportunities to influence equipment
survivability.

3.22: Preventive Maintenance (PM):

Maintenance repairs performed on a regular schedule to minimize component degradation and

extend the life of equipment. Preventive maintenance is performed after a set amount of elapsed
calendar time or machine run time, regardless of whether the repair is needed. While more
costeffective than reactive maintenance, preventive maintenance still requires substantial human
resources and replacement parts inventories. It may be a daily maintenance (cleaning, inspection,
oiling and re-tightening), designed to retain the healthy condition of equipment and prevent
failure through the prevention of deterioration, periodic inspection or equipment condition
diagnosis, to measure deterioration. It entails understanding and maintaining all the physical
elements of manufacturing-machine components, equipment, and systems- so that they
consistently perform at all levels required of them. Such maintenance is usually scheduled by
providing for monitoring inspections and special operating procedures. The intent of PM is to
“prevent” maintenance problems or failures before they take place by following routine and
comprehensive maintenance procedures. The goal is to achieve fewer, shorter, and more
predictable outages.

Advantages of PM

1. It is predictable, making budgeting, planning, and resource levelling possible.

2. When properly practiced, it generally prevents most major problems, thus reducing forced
outages, “reactive maintenance,” and maintenance costs in general.
3. It assures managers that equipment is being maintained.
4. It is easily understood and justified.

Disadvantages of PM

1. It is time consuming and resource intensive.

2. It does not consider actual equipment condition when scheduling or performing the
maintenance.

3. It can cause problems in equipment in addition to solving them (e.g.damaging seals,

stripping threads).

It is further divided into periodic maintenance and predictive maintenance. Just like human life is
extended by preventive medicine, the equipment service life can be prolonged by doing
preventive maintenance.
a. Periodic Maintenance (Time based maintenance - TBM): Time based maintenance consists
of periodically inspecting, servicing and cleaning equipment and replacing parts to prevent
sudden failure and process problems.

b. Predictive Maintenance: This is a method in which the service life of important part is
predicted based on inspection or diagnosis, in order to use the parts to the limit of their service
life. Compared to periodic maintenance, predictive maintenance is condition based maintenance.
Predictive maintenance programs measure equipment on a regular basis, track the measurements
over time, and take corrective action when measurements are about to go outside the equipment
operating limits. Repairing equipment as-needed requires fewer man-hours and parts than
preventive maintenance. However, tracking the measurements requires new tools, training, and
software to collect and analyze the data and predict repair cycles. It manages trend values, by
measuring and analyzing data about deterioration and employs a surveillance system, designed to
monitor conditions through an on-line system.

3.23 Corrective Maintenance: It improves equipment and its components so that preventive
maintenance can be carried out reliably. Equipment with design weakness must be redesigned to
improve reliability or improving maintainability.

3.24 Condition Based Maintenance The condition of the equipment or some critical parts of the
equipment are continuously monitored using sophisticated monitoring instruments so that failure
may be predicted well before it occurs and corrective steps are taken to prevent failure.

3.25 Design Out Maintenance A design out maintenance is a design oriented curative means
aimed at rectifying a design defect originated from improper method of installation or poor
choice of materials etc. It calls for strong design and maintenance interface. Design out
maintenance aims to eliminate the cause of maintenance.

3.26 Opportunistic Maintenance When equipment is taken down for maintenance of one of
few worn out parts, the opportunity can be utilized to change or maintain other parts which are
wearing out even though they have yet to fail. This maintenance strategy is for non-monitored
components.

3.27. Proactive Maintenance Unlike the three type of maintenance strategies which has been
discussed earlier, proactive maintenance can be considered as an another new approach to
maintenance strategy. Dissimilar to preventive maintenance that based on time intervals or
predictive maintenance that based on condition monitoring, proactive maintenance concentrate
on the monitoring and correction of root causes to equipment failures. The proactive
maintenance strategy is also designed to extend the useful age of the equipment to reach the
wear-out stage by adaptation a high mastery level of operating precision.

3.28 Reliability Centered Maintenance (RCM) Recently, reliability centered maintenance has
been defined as “an approach to maintenance that combines reactive, preventive, predictive, and
proactive maintenance practices and strategies to maximize the life that a piece of equipment
functions in the required manner.” RCM is an approach that tried to create an optimum mixture
of an intuitive approach and a rigorous statistical approach to deciding how to maintain facility
equipment.

3.3. Inventory Control:

The amount of material, a company has in stock at a specific time is known as inventory or in
terms of money it can be defined as the total capital investment over all the materials stocked in
the company at any specific time. Inventory may be in the form of,

 raw material inventory

 in process inventory
 finished goods inventory
 spare parts inventory
 office stationary etc.

As a lot of money is engaged in the inventories along with their high carrying costs, companies
cannot afford to have any money tied in excess inventories. Any excessive investment in
inventories may prove to be a serious drag on the successful working of an organization. Thus
there is a need to manage our inventories more effectively to free the excessive amount of capital
engaged in the materials.

3.31 Why Inventories?

Inventories are needed because demand and supply can not be matched for physical and
economical reasons. There are several other reasons for carrying inventories in any organization.

 To safe guard against the uncertainties in price fluctuations, supply conditions, demand
conditions, lead times, transport contingencies etc.
 To reduce machine idle times by providing enough in-process inventories at appropriate
locations.
 To take advantages of quantity discounts, economy of scale in transportation etc.
 To decouple operations i.e. to make one operation's supply independent of another's
supply. This helps in minimizing the impact of break downs, shortages etc. on the
performance of the down stream operations. Moreover operations can be scheduled
independent of each other if operations are decoupled.
 To reduce the material handling cost of semi-finished products by moving them in large
quantities between operations.
 To reduce clerical cost associated with order preparation, order procurement etc.

3.32 Inventory Costs

In order to control inventories appropriately, one has to consider all cost elements that are
associated with the inventories. There are four such cost elements, which do affect cost of
inventory.
  Unit cost: it is usually the purchase price of the item under consideration. If unit cost is
related with the purchase quantity, it is called as discount price.
 Procurement costs: This includes the cost of order preparation, tender placement, cost of
postages, telephone costs, receiving costs, set up cost etc.
 Carrying costs: This represents the cost of maintaining inventories in the plant. It includes
the cost of insurance, security, warehouse rent, taxes, interest on capital engaged,
spoilage, breakage etc.
 Stockout costs: This represents the cost of loss of demand due to shortage in supplies.
This includes cost of loss of profit, loss of customer, loss of goodwill, penalty etc.

If one year planning horizon is used, the total annual cost of inventory can be expressed as:

Total annual inventory cost = Cost of items + Annual procurement cost + Annual carrying
cost + Stockout cost

3.33 Variables in Inventory Models

D = Total annual demand (in units)

Q = Quantity ordered (in units)

Q* = Optimal order quantity (in units)

R = Reorder point (in units)

R* = Optimal reorder point (in units)

L = Lead time

S = Procurement cost (per order)

C = Cost of the individual item (cost per unit)

I = Carrying cost per unit carried (as a percentage of unit cost C)

K = Stockout cost per unit out of stock

P = Production rate or delivery rate

dl = Demand per unit time during lead time

Dl = Total demand during lead time

TC = Total annual inventory costs

TC* = Minimum total annual inventory costs

Number of orders per year =

Total procurement cost per year = S.D / Q

Total carrying cost per year = Carrying cost per unit * unit cost * average inventory per cycle

Cost of items per year = Annual demand * unit cost

= D.C

Total annual inventory cost (TC) =

The objective of inventory management team is to minimize the total annual inventory cost. A
simplified graphical presentation in which cost of items, procurement cost and carrying cost are
depicted is shown in Figure 3.2 . It can be seen that large values of order quantity Q result in
large carrying cost. Similarly, when order quantity Q is large, fewer orders will be placed and
procurement cost will decrease accordingly. The total cost curve indicates that the minimum cost
point lies at the intersection of carrying cost and procurement cost curves.

Inventory Modelling

This is a quantitative approach for deriving the minimum cost model for the inventory problem
in hand.

Economic Order Quantity (EOQ) Model

This model is applied when objective is to minimize the total annual cost of inventory in the
organization. Economic order quantity is that size of the order which helps in attaining the above
set objective. EOQ model is applicable under the following conditions.

 Demand per year is deterministic in nature

 Planning period is one year
 Lead time is zero or constant and deterministic in nature
 Replenishment of items is instantaneous
 Demand/consumption rate is uniform and known in advance
 No stockout condition exist in the organization

The total annual cost of the inventory (TC) is given by the following equation in EOQ model.

The graphical representation of the EOQ model is shown in Figure 3.3

A numeric illustration of the EOQ model is given in following example

Example 1

ABC manufacturers produces 1,25,000 oil seals each year to satisfy the requirement of their
client. They order the metal for the bushing in lot of 30,000 units. It cost them $40 to place the
order. The unit cost of bushing is $0.12 and the estimated carrying cost is 25% unit cost. Find out
the economic order quantity? What percentage of increases or decrease in order quantity is
required so that the ordered quantity is Economic order quantity ?
3.4: Replacement Analysis:

Replacement analysis is carried out when there is a need to replace or augment the currently
owned equipment (or any asset). There are various reasons that result in replacement of a given
equipment. One of the reasons is the reduction in the productivity of currently owned equipment.
This occurs due to physical deterioration of its different parts and there is decrease in operating
efficiency with age. In addition to reduced productivity, there is also increase in operating and
maintenance cost for the construction equipment due to physical deterioration. This necessitates
the replacement of the existing one with the new alternative. Similarly if the production demands
a change in the desired output from the equipment, then there is requirement of augmenting the
existing equipment for meeting the required demand or replacing the equipment with the new
one. Another reason for replacement of the existing equipment is obsolescence. Due to rapid
change in the technology, the new model with latest technology is more productive than the
currently owned equipment, although the currently owned equipment is still operational and
functions acceptably. Thus continuing with the existing equipment may increase the production
cost. The impact of rapid change in technology on productivity is more for the equipment with
more automated facility than the equipment with lesser automation.

In replacement analysis, the existing (i.e. currently owned) asset is referred as defender whereas
the new alternatives are referred as challengers. In this analysis the ‘outsider perspective' is
taken to establish the first cost of the defender. This initial cost of the defender in replacement
analysis is nothing but the estimated market value from perspective of a neutral party. In other
words this cost is the investment amount which is assigned to the currently owned asset (i.e.
defender) in the replacement analysis. The current market value represents the opportunity cost
of keeping the defender i.e. if the defender is selected to continue in the service. In other words,
if the defender is selected, the opportunity to obtain its current market value is forgone.
Sometimes the additional cost required to upgrade the defender to make it competitive for
comparison with the new alternatives is added to its market value to establish the total
investment for the defender. Along with the market value, there will be revised estimates for
annual operating and maintenance cost, salvage value and remaining service life of the defender,
which are expected to be different from the original values those were estimated at the time of
acquiring the asset. The past estimates of initial cost, annual operating and maintenance cost,
salvage value and useful life of defender are not relevant in the replacement analysis and are thus
neglected. The past estimates also incorporate a sunk costwhich is considered irrelevant in
replacement analysis. Sunk cost occurs when the book value (as determined using depreciation
method) of an asset is greater than its current market value, when the asset (i.e. defender) is
considered for replacement. In other words it represents the amount of past capital investment
which can not be recovered for the existing asset under consideration for replacement. Sunk cost
may occur due to incorrect estimates of different cost components and factors related
productivity of the defender, those were made at the time of original estimates in the past with
uncertain future conditions. Since sunk cost represents a loss in capital investment of the asset,
the income tax calculations can be done accordingly by considering this capital loss. In
replacement analysis the incorrect past estimates and decisions should not be considered and
only the cash flows (both present and future) applicable to replacement analysis should be
included in the economic analysis. For replacement analysis, it is important know about different
lives of an asset, as this will assist in making the appropriate replacement decision. The different
lives are physical life, economic life and useful life. Physical life of an asset is defined as the
time period that is elapsed between initial purchase (i.e. original acquisition) and final disposal or
abandonment of the asset. Economic life is defined as the time period that minimizes the total
cost (i.e. ownership cost plus operating cost) of an asset. It is the time period that results in
minimum equivalent uniform annual worth of the total cost of the asset. Useful life is defined as
the time period during which the asset is productively used to generate profit. In replacement
analysis the defender and challenger is compared over a study period. Generally the remaining
life of the defender is less than or equal to the estimated life of the challenger. When the
estimated lives of the defender and challenger are not equal, the duration of the study period has
to be appropriately selected for the replacement analysis. When the estimated lives of defender
and challenger are equal, annual worth method or present worth method may be used for
comparison between defender and the challengers (new alternatives).

In the following example, replacement analysis involving equal lives of defender and challenger
is discussed.

Example - 2

A construction company has purchased a piece of construction equipment 3 years ago at a cost of
Rs.4000000. The estimated life and salvage value at the time of purchase were 12 years and
Rs.850000 respectively. The annual operating and maintenance cost was Rs.150000. The
construction company is now considering replacement of the existing equipment with a new
model available in the market. Due to depreciation, the current book value of the existing
equipment is Rs.3055000. The current market value of the existing equipment is Rs.2950000.
The revised estimate of salvage value and remaining life are Rs.650000 and 8 years respectively.
The annual operating and maintenance cost is same as earlier i.e. Rs.150000.

The initial cost of the new model is Rs.3500000. The estimated life, salvage value and annual
operating and maintenance cost are 8 years, Rs.900000 and Rs.125000 respectively. Company's
MARR is 10% per year. Find out whether the construction company should retain the ownership
of the existing equipment or replace it with the new model, if study period is taken as 8 years
(considering equal life of both defender and challenger).

Solution:

For the replacement analysis, initial cost (Rs.4000000), initial estimate of salvage value
(Rs.850000) and remaining life (12 – 3 = 9 years) and current book value (Rs.3055000) of the
existing equipment (i.e. defender) are irrelevant. Similarly sunk cost of Rs.105000 (Rs.3055000
– Rs.2950000) is also not relevant for the replacement analysis. For the replacement analysis the
current revised estimates of the existing equipment will be used.

For existing equipment (defender),

Current market value (P) = Rs.2950000, Salvage value (F) = Rs.650000,

Annual operating and maintenance cost (A) = Rs.150000, Study period (n) = 8 years.
For new model (challenger),

Initial cost (P) = Rs.3500000, Salvage value (F) = Rs.900000,

Annual operating and maintenance cost (A) = Rs.125000, Study period (n) = 8 years.

Now the equivalent uniform annual worth of both defender (i.e. the existing equipment) and
challenger (i.e. the new model) at MARR of 10% (i.e. i = 10%) are calculated as follows;

For defender;

For challenger;

From the above calculations, it is observed that equivalent uniform annual cost of the defender is
less than that of the challenger. Thus the construction company should continue in retaining the
ownership of the defender against the challenger with above details. Since the useful lives of
defender and challenger are equal, the same conclusion will also be obtained by using present
worth method for economic evaluation.
Unit 4:MANAGEMENT CONCEPTS

4.1: Development of management principles: Managing is one of the most important

human activities. From the time human beings began forming social organizations to accomplish
aims and objectives they could not accomplish as individuals, managing has been essential to
ensure the coordination of individual efforts. As society continuously relied on group effort, and
as many organized groups have become large, the task of managers has been increasing in
importance and complexity. Henceforth, managerial theory has become crucial in the way
managers manage complex organizations.

4.11 Definition of Management: Management is the art, or science, of achieving goals

through people. Since managers also supervise, management can be interpreted to mean literally
“looking over” – i.e., making sure people do what they are supposed to do. Managers are,
therefore, expected to ensure greater productivity or, using the current jargon, ‘continuous
improvement’.

More broadly, management is the process of designing and maintaining an environment in which
individuals, working together in groups, efficiently accomplish selected aims (Koontz and
Weihrich). In its expanded form, this basic definition means several things. First, as managers,
people carry out the managerial functions of planning, organizing, staffing, leading, and
controlling. Second, management applies to any kind of organization. Third, management
applies to managers at all organizational levels. Fourth, the aim of all managers is the same – to
create surplus. Finally, managing is concerned with productivity – this implies effectiveness and
efficiency.

First and foremost, management is about solving problems that keep emerging all the time in the
course of an organization struggling to achieve its goals and objectives. Problem solving should
be accompanied by problem identification, analysis and the implementation of remedies to
managerial problems. Second, administration involves following laid down procedures (although
procedures or rules should not be seen as ends in themselves) for the execution, control,
communication, delegation and crisis management. Third, human resource management should
be based on strategic integration of human resource, assessment of workers, and exchange of
ideas between shareholders and workers. Finally, organizational leadership should be developed
a long lines of interpersonal relationship, teamwork, self-motivation to perform, emotional
strength and maturity to handle situations, personal integrity, and general management skills.

4.12: Management Objectives, Functions, Goals, and Essentiality

Management Objectives

There are basically three management objectives. One objective is ensuring organizational goals
and targets are met – with least cost and minimum waste. The second objective is looking after
health and welfare, and safety of staff. The third objective is protecting the machinery and
resources of the organization, including the human resources.

Management Functions

To understand management, it is imperative that we break it down into five managerial

functions, namely; planning, organizing, staffing, leading (Directing), and controlling.

Planning involves selecting missions and objectives and the actions to achieve them. It requires
decision-making – i.e., choosing future courses of action from among alternatives. Plans range
from overall purposes and objectives to the most detailed actions to be taken. No real plan exists
until a decision – a commitment of human and material resources – has been made. In other
words, before a decision is made, all that exists is planning study, analysis, or a proposal; there is
no real plan.

People working together in groups to achieve some goal must have roles to play. Generally,
these roles have to be defined and structured by someone who wants to make sure that people
contribute in a specific way to group effort. Organizing, therefore, is that part of management
that involves establishing an intentional structure of roles for people to fill in an organization.
Intentional in that all tasks necessary to accomplish goals are assigned and assigned to people
who can do the best. Indeed, the purpose of an organizational structure is to help in creating an
environment for human performance. However, designing an organizational structure is not an
easy managerial task because many problems are encountered in making structures fit situations,
including both defining the kind of jobs that must be done and finding the people to do them.

Staffing involves filling, and keeping filled, the positions in the organization structure. This is
done by identifying work-force requirements; inventorying the people available; and recruiting,
selecting, placing, promoting, appraising, planning the careers of, compensating, and training or
otherwise developing both candidates and current jobholders to accomplish their tasks
effectively and efficiently.

Leading is the influencing of people so that they will contribute to organization and group goals;
it has to do predominantly with the interpersonal aspect of managing. Most important problems
to managers arise from people – their desires and attitudes, their behavior as individuals and in
groups. Hence, effective managers need to be effective leaders. Leading involves motivation,
leadership styles and approaches and communication. Controlling, for example, budget for
expense, is the measuring and correcting of activities of subordinates to ensure that events
conform to plans. It measures performance against goals and plans, shows where negative
deviations exist, and, by putting in motion actions to correct deviations, helps ensure
accomplishment of plans. Although planning must precede controlling, plans are not self-
achieving. Plans guide managers in the use of resources to accomplish specific goals; then
activities are checked to determine whether they conform to the plans. Compelling events to
conform to plans means locating the persons who are responsible for results that differ from
planned action and then taking the necessary steps to improve performance. Thus, controlling
what people do controls organizational outcomes.

Finally, coordination is the essence of manager-ship for achieving harmony among individual
efforts toward the accomplishment of group goals. Each of the managerial functions discussed
earlier on is an exercise contributing to coordination. Because individuals often interpret similar
interests in different ways, and their efforts toward mutual goals do not automatically mesh with
the efforts of others, it, thus, becomes the central task of the manager to reconcile differences in
approach, timing, effort, or interest, and to harmonize individual goals to contribute to
organizational goals.

Although these management functions concern the internal environment for performance within
an organization, managers must operate in the external environment of an organization as well.
Clearly, managers cannot perform their tasks well unless they have an understanding of, and are
responsive to, the many elements of the external environment – economic, technological, social,
political, and ethical factors – that affect their areas of operation.

4.2 Management Theories:

Contemporary theories of management tend to account for and help interpret the rapidly
changing nature of today’s organizational environments. This deal with several important
management theories which are broadly classified as follows:

The Scientific Management theory comprising the works of Frederick W. Taylor and Lillian
Gilbreth’s motion study, among others; the Classical Organizational Theory School comprising
the works of Henri Fayol’s views on administration, and Max Weber’s idealized bureaucracy,
among others; Behavioral theories comprising the work of Elton Mayo and his associates; the
Management Science School which we discuss at the end of this section; and Recent
Developments in Management Theory comprising works such as Systems Approach, Situational
or Contingency theory, Chaos theory, and Team Building approach. For lack of time and space,
this discussion will provide a general description of some of the scholars in each of these
management theories and the successes that they achieved.

4.21 Scientific Management Theory:

The first management theory is what is popularly referred to as Frederick Taylor’s Scientific
Management. Frederick Taylor started the era of modern management. In the late nineteenth and
early twentieth century’s, he was decrying the “awkward, inefficient, or ill-directed movements
of men” as national loss. Taylor consistently sought to overthrow management “by rule of
thumb” and replace it with actual timed observations leading to “the one best” practice. He also
advocated the systematic training of workers in “the one best practice” rather than allowing them
personal discretion in their tasks. He further believed that the workload would be evenly shared
between the workers and management with management performing the science and instruction
and the workers performing the labor, each group doing “the work for which it was best suited”.

Taylor’s strongest positive legacy was the concept of breaking a complex task down into a
number of subtasks, and optimizing the performance of the subtasks; hence, his stop-watch
measured time trials. However, many critics both historical and contemporary have pointed out
that Taylor’s theories tend to “dehumanize” the workers.

Nevertheless, Taylor’s postulations were strongly influenced by his social/historical period

(1856-1917) during the Industrial Revolution; it was a period of autocratic management that saw
Taylor turning to “science”(hence, his principles of scientific management) as a solution to the
inefficiencies and injustices of the period. It has to be stated that scientific management met with
significant success among which included: the science of cutting metal, coal shovel design that
he produced at Bethlehem Steel Works (reducing the workers needed to shovel from 500 to 140),
worker incentive schemes, a piece rate system for shop management, and organizational
influences in the development of the fields of industrial engineering, personnel, and quality
control.

It has to be acknowledged that from an economic standpoint, Taylorism was an extreme success.
Application of his methods yielded significant improvements in productivity. For example,
improvements such as his shovel work at Bethlehem Works, which reduced the workers needed
to shovel from 500 to 140. Henceforth, Taylor proposed four great underlying principles of
management.

First, there is need to develop a ‘science of work’ to replace old rule-of-thumb methods: pay and
other rewards linked to achievement of ‘optimum goals’ – measures of work performance and
output; failure to achieve these would in contrast result in loss of earnings. Second, workers to be
‘scientifically’ selected and developed: training each to be ‘first-class’ at some specific task.
There, the ‘science of work’ to be brought together with scientifically selected and trained people
to achieve the best results. Finally, work and responsibility to be divided equally between
workers and management cooperating together in close interdependence.

Alongside Taylor’s postulates is Gilbreth’s motion study. The ultimate result of this study led to
the centrality of efficiency in organizations. Gilbreth was particularly interested in how he could
reduce the unnecessary motions resulting from bricklaying at a construction site; he succeeded in
reducing the motions from 18 to 4. He then proposed that each worker should be involved in
doing his or her own work, prepare for the next higher level, and training their successors.

4.23 Classical Organizational Theory:

In this category of management theory are the works of Max Weber’s bureaucratic theory and
Henri Fayol’s administrative theory. Weber postulated that western civilization was shifting from
“wert rational” (or value oriented) thinking, affective action (action derived from emotions), and
traditional action (action derived from past precedent) to “zweckational” (or technocratic)
thinking. He believed that civilization was changing to seek technically optimal results at the
expense of emotional or humanistic content.

Weber then developed a set of principles for an “ideal” bureaucracy as follows: fixed and official
jurisdictional areas, a firmly ordered hierarchy of super and subordination, management based on
written records, thorough and expert training, official activity taking priority over other activities
and that management of a given organization follows stable, knowable rules. The bureaucracy
was envisioned as a large machine for attaining its goals in the most efficient manner possible.

However, Weber was cautious of bureaucracy when he observed that the more fully realized, the
more bureaucracy “depersonalizes” itself – i.e., the more completely it succeeds in achieving the
exclusion of love, hatred, and every purely personal, especially irrational and incalculable,
feeling from execution of official tasks. Hence, Weber predicted a completely impersonal
organization with little human level interaction between its members.

Henri Fayol’s administrative theory mainly focuses on the personal duties of management at a
much more granular level. In other words, his work is more directed at the management layer.
Fayol believed that management had five principle roles: to forecast and plan, to organize, to
command, to co-ordinate, and to control. Forecasting and planning was the act of anticipating the
future and acting accordingly. Organization was the development of the institution’s resources,
both material and human. Commanding was keeping the institution’s actions and processes
running. Co-ordination was the alignment and harmonization of the group’s efforts. Finally,
control meant that the above activities were performed in accordance with appropriate rules and
procedures.

Fayol developed fourteen principles of administration to go along with management’s five

primary roles. These principles are: specialization/division of labor, authority with responsibility,
discipline, unity of command, unity of direction, subordination of individual interest to the
general interest, remuneration of staff, centralization, scalar chain/line of authority, order, equity,
stability of tenure, initiative, and esprit de corps. Fayol clearly believed personal effort and team
dynamics were part of an “ideal” organization.

Fayol’s five principle roles (Plan, Organize, Command, Co-ordinate, and Control) of
management are still actively practiced today. The concept of giving appropriate authority with
responsibility is also widely commented on and is well practiced. Unfortunately, his principles of
“unity of command” and “unity of direction” are consistently violated in “matrix management”,
the structure of choice for many of today’s companies.
4.24 Behavioral Theories:

The key scholar under this category is Elton Mayo. The origin of behavioralism is the human
relations movement that was a result of the Hawthorne Works Experiment carried out at the
Western Electric Company, in the United States of America that started in the early 1920s (1927-
32). Elton Mayo and his associates’ experiments disproved Taylor’s beliefs that science dictated
that the highest productivity was found in ‘the one best way’ and that way could be obtained by
controlled experiment. The Hawthorne studies attempted to determine the effects of lighting on
worker productivity. When these experiments showed no clear correlation between light level
and productivity the experiments then started looking at other factors. These factors that were
considered when Mayo was working with a group of women included rest breaks, no rest breaks,
no free meals, more hours in the work-day/work-week or fewer hours in the workday/work-
week. With each of these changes, productivity went up. When the women were put back to their
original hours and conditions, they set a productivity record.

These experiments proved five things. First, work satisfaction and hence performance is
basically not economic – depends more on working conditions and attitudes - communications,
positive management response and encouragement, working environment. Second, it rejected
Taylorism and its emphasis on employee self-interest and the claimed over-riding incentive of
monetary rewards. Third, large-scale experiments involving over 20,000 employees showed
highly positive responses to, for example, improvements in working environments (e.g.,
improved lighting, new welfare/rest facilities), and expressions of thanks and encouragement as
opposed to coercion from managers and supervisors. Fourth, the influence of the peer group is
very high – hence, the importance of informal groups within the workplace. Finally, it
denounced ‘rabble hypotheses’ that society is a horde of unorganized individuals (acting) in a
manner calculated to secure his or her self-preservation or self-interest.

These results showed that the group dynamics and social makeup of an organization were an
extremely important force either for or against higher productivity. This outcome caused the call
for greater participation for the workers, greater trust and openness in the working environment,
and a greater attention to teams and groups in the work place. Finally, while Taylor’s impacts
were the establishment of the industrial engineering, quality control and personnel departments,
the human relations movement’s greatest impact came in what the organization’s leadership and
personnel department were doing. The seemingly new concepts of “group dynamics”,
“teamwork”, and organizational “social systems”, all stem from Mayo’s work in the mid-1920s.

4.25 Recent Developments in Management Theory

Under this category of theory are the Systems Approach, Situational or Contingency theory,
Chaos theory, and Team Building theory.

The systems theory has had a significant effect on management science and understanding
organizations. A system is a collection of part unified to accomplish an overall goal. If one part
of the system is removed, the nature of the system is changed as well. A system can be looked at
as having inputs (e.g., resources such as raw materials, money, technologies, people), processes
(e.g., planning, organizing, motivating, and controlling), outputs (products or services) and
outcomes (e.g., enhanced quality of life or productivity for customers/clients, productivity).
Systems share feedback among each of these four aspects of the system.

The Systems Theory may seem quite basic. Yet, decades of management training and practices
in the workplace have not followed this theory. Only recently, with tremendous changes facing
organizations and how they operate, have educators and managers come to face this new way of
looking at things. The effect of systems theory in management is that it helps managers to look at
the organization more broadly. It has also enabled managers to interpret patterns and events in
the workplace – i.e., by enabling managers to recognize the various parts of the organization,
and, in particular, the interrelations of the parts.

The situational or contingency theory asserts that when managers make a decision, they must
take into account all aspects of the current situation and act on those aspects that are key to the
situation at hand. Basically, it is the approach that “it depends”. For example, if one is leading
troops in Iraq, an autocratic style is probably best. If one is leading a hospital or University, a
more participative and facilitative leadership style is probably best.

The Chaos theory is advocated by Tom Peters (1942). As chaotic and random as global events
seem today, they are equally chaotic in organizations. Yet for many decades, managers have
acted on the basis that organizational events can always be controlled. Thus, a new theory,
known as chaos theory, has emerged to recognize that events are rarely controlled. Chaos
theorists suggest that systems naturally go to more complexity, and as they do so, they become
more volatile and must, therefore, expend more energy to maintain that complexity. As they
expend more energy, they seek more structure to maintain stability. This trend continues until the
system splits, combines with another complex system or falls apart entirely. It will need an
effective manager for the latter worst scenario not to happen.

The last management theory is the Team Building approach or theory. This theory emphasizes
quality circles, best practices, and continuous improvement. It is a theory that mainly hinges on
reliance on teamwork. It also emphasizes flattening of management pyramid, and reducing the
levels of hierarchy. Finally, it is all about consensus management – i.e., involving more people at
all levels in decision-making.

4.26 Other Management Theories

In this category are the works of Edward W. Deming and Douglas McGregor. Edward Deming is
the founder of modern quality management and is regarded by the Japanese as the key influence
in their postwar economic miracle. He postulated several assumptions: create constancy of
purpose for continual improvement of products and service; adopt the new philosophy created in
Japan; cease dependence on mass inspection; build quality along with price; improve constantly
and forever every process planning, production, and service; institute modern methods of
training on-the-job for including management; adopt and institute leadership aimed at helping
people to do a better job; drive out fear, encourage effective two-way communication; break
down barriers between departments and staff areas; eliminate exhortations for the workforce –
they only create adversarial relationships; eliminate quotas and numerical targets; remove
barriers to pride of workmanship, including annual appraisals and Management by Objectives;
encourage education and self-improvement for everyone; and define top management’s
permanent commitment to ever improving quality and productivity and their obligation to
implement all these principles.

4.27 Douglas McGregor (1906-1964) postulated management ideas as contained in “Theory

X” and “Theory Y”. Using human behavior research, he noted that the way an organization
runs depends on the beliefs of its managers “Theory X” gives a negative view of human behavior
and management that he considered to have dominated management theory from Fayol onwards
– especially Taylorism. It also assumes that most people are basically immature, need direction
and control, and are incapable of taking responsibility. They are viewed as lazy, dislike work and
need a mixture of financial inducements and threat of loss of their job to make them work
(‘carrot and stick’ mentality).

“Theory Y”, the opposite of “Theory X”, argues that people want to fulfill themselves by seeking
self-respect, self-development, and self-fulfillment at work as in life in general. The six basic
assumptions for ‘Theory Y’ are: work is as natural as play or rest – the average human being
does not inherently dislike work, whether work is a source of pleasure or a punishment (to be
avoided) depends on nature of the work and its management. Second, effort at work need not
depend on threat of punishment – if committed to objectives then selfdirection and self-control
rather than external controls. Third, commitment to objectives is a function of the rewards
associated with their achievement. Satisfaction of ego and self-actualization needs can be
directed towards the objectives of the organization. Fourth, the average human being learns,
under proper conditions, not only to accept but to seek responsibility. Fifth, high degrees of
imagination, ingenuity and creativity are not restricted to a narrow group but are widely
distributed in the population. Lastly, under the conditions of modern industrial life, the
intellectual potentials of the average human being are being only partly utilized.

There is, however, one theory or approach, the quantitative approach that is hardly used and
known by managers. It emerges from operations research and management science. It is a
mathematical and statistical solution to problems using optimization models, and computer
simulations. It is most effective management decision-making rather than managerial behavior.
The management theories that have been discussed, important as they are, have to be translated
in practice by managers. To this discussion I now turn.
4.28 Management as Practice:

Managing, like all other practices – whether medicine, music composition, engineering,
accountancy, or even baseball – is an art; it is know-how. It is doing things in the light of the
realities of a situation.

Yet managers can work better by using the organized knowledge about management. It is this
knowledge that constitutes science. However, the science underlying managing is fairly crude
and inexact. This is true because the many variables with which managers deal are extremely
complex. Nevertheless, such management knowledge can certainly improve managerial practice.
Managers who attempt to manage without management science must put their trust to luck,
intuition, or what they did in the past.

In managing, as in any other field, unless practitioners are to learn by trial and error, there is no
place they can turn for meaningful guidance other than the accumulated knowledge underlying
their practice; this accumulated knowledge is theory.

For practical purposes, all managers must develop three sets of skills, namely; conceptual,
technical, and human (see Fleet and Perterson 1994). Conceptual skills allow the manager to
develop relationships between factors that other people may not see. Managers who have well-
developed conceptual skills are able to apply different management theories to the same
situation. For a manager to be technical, it implies that he or she should act professionally.
Professionalism demands that the manager performs his or her duties within established
procedures, rules and regulations. Any behavior that compromises the manager’s professional
etiquette is certainly bound to interfere adversely with the organization’s productivity. Lastly, a
manager should be able to see members of the organization as human beings who have needs and
psychological feelings and emotions. These needs and feelings must be positively harnessed for
the good of the organization; motivation of the employees, therefore, becomes a critical factor in
increasing productivity.

4.3 Production Cost Concepts:

Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of
production of goods or rendering services

Cost in simple, words, means the total of all expenses. Cost is also defined as the amount of
expenditure (actual or notional) incurred on or attributable to a given thing or to ascertain the
cost of a given thing. Thus it is that which is given or in sacrificed to obtain something. The cost
of an article consists of actual outgoings or ascertained charges incurred in its production and
sale. Cost is a generic term and it is always advisable to qualify the word cost to show exactly
what it meant, e.g., prime cost, factory cost, etc. Cost is also different from value as cost is
measured in terms of money whereas value in terms of usefulness or utility of an article.

4.31 Elements of Cost

Figure 4.1: Elements of Cost

Direct Material + Direct Labour + Direct Expenses = Prime Cost

Indirect Material+ Indirect Labour + Indirect Expenses = Overheads

4.32 Direct Material Cost:

Direct material cost can be defined as ‘The Cost of material which can be attributed to a cost
object in an economically feasible way’. Direct materials are those materials which can be
identified in the product and can be conveniently measured and directly charged to the product.
Thus, these materials directly enter the product and form a part of the finished product. For
example, timber in furniture making, cloth in dress making, bricks in building a house. The
following are normally classified as direct materials :

(i) All raw materials, like jute in the manufacture of gunny bags, pig iron in foundry and
fruits in canning industry.
(ii) Materials specifically purchased for a specific job, process or order, like glue for
book binding, starch powder for dressing yarn.
(iii) Parts or components purchased or produced, like batteries for transistor-radios.
(iv) Primary packing materials like cartons, wrappings, card-board boxes, etc.
4.33 Indirect Material Cost
Materials, the costs of which cannot be directly attributed to a particular cost object is known as
indirect material cost. Indirect materials are those materials which do not normally form a part of
the finished product. It has been defined as “materials which cannot be allocated but which can
apportion to or absorbed by cost centres or cost units”. These are:
(i) Stores used in maintenance of machinery, buildings, etc., like lubricants, cotton
waste, bricks and cements.
(ii) Stores used by the service departments, i.e., non-productive departments like Power
House, Boiler House and Canteen, etc., and
(iii) Materials which due to their cost being small, are not considered worthwhile to be
treated as direct materials.

4.34 Direct Labour / Employee Cost:

The cost of employees which can be attributed to a cost object in an economically feasible way.
In simple words, it is that labour which can be conveniently identified or attributed wholly to a
particular job, product or process or expended in converting raw materials into finished goods.
Wages of such labour are known as direct wages. Thus it includes payment made to the
following groups of labour:
(i) Labour engaged on the actual production of the product or in carrying out of an
operation or process.
(ii) Labour engaged in adding the manufacture by way of supervision, mainte nance, tool
setting, transportation of material etc.
(iii) Inspectors, analysts etc., specially required for such production. Indirect Labour/
Employee Cost The labour / employee cost which cannot be directly attributed to a
particular cost object.

The wages of that labour which cannot be allocated but which can be apportioned to or absorbed
by cost centres or cost units is known as Indirect Labour. In other words paid to labour which
are employed other than on production constitute indirect labour costs. Example of such labour
are: charge-hands and supervisors; maintenance work ers; men employed in service departments,
material handling and internal transport; apprentices, trainees and instructors; clerical staff and
labour employed in time office and security office.

4.35 Direct or Chargeable Expenses:

Direct expenses are expenses relating to manufacture of a product or rendering a service which
can be identified or linked with the cost object other than direct material cost and direct
employee cost. Direct expenses include all expenditure other than direct material or direct labour
that is specifically incurred for a particular product or process. Such expenses are charged
directly to the particular cost account concerned as part of the prime cost. Examples of direct
expenses are:
(i) Excise duty;
(ii) Royalty;
(iii) Architect or Supervisor’s fees;
(iv) Cost of rectifying defective work;
(v) Travelling expenses to the city;
(vi) Experimental expenses of pilot projects;
(vii) Expenses of designing or drawings of patterns or models;
(viii) Repairs and maintenance of plant obtained on hire; and
(ix) Hire of special equipment obtained for a contract.

4.36 Indirect Expenses:

Indirect expenses are expenses which cannot be allocated but which can be apportioned
to or absorbed by cost centres or cost units such as rent, insurance, municipal taxes, general
manager salary and canteen and welfare expenses, power and fuel, cost of training new employee
lighting and heating, telephone expenses, etc.,

4.37 Overheads:

Overheads comprise of indirect materials, indirect employee cost and indirect expenses which
are not directly identifiable or allocable to a cost object. Overheads may defined as the aggregate
of the cost of indirect material, indirect labour and such other expenses including serv ices as
cannot conveniently be charged directly to specific cost units. Thus overheads are all expenses
other than direct expenses. In general terms, overheads comprise all expenses incurred for or in
connection with, the general organization of the whole or part of the undertaking, i.e., the cost of
operating supplies and services used by the undertaking and in cludes the maintenance of capital
assets.

4.38 Prime Cost (The aggregate of Direct Material, Direct Labour and Direct Expenses.)
Generally it constitutes 50% to 80% of the total cost of the product, as such, as it is primary to
the cost of the product and called Prime Cost. Cost Object Cost object is the technical name for a
product or a service, a project, a department or any activity to which a cost relates. Therefore the
term cost should always be linked with a cost object to be more meaningful. Establishing a
relevant cost object is very crucial for a sound costing system. The Cost object could be defined
broadly or narrowly. At a broader level a cost object many be named as a Cost Centre, where as
at a lowermost level it may be called as a Cost Unit.
4.39 Cost Centre
CIMA defines a cost centre as “a location, a person, or an item of equipment (or a group of
them) in or connected with an undertaking, in relation to which costs ascertained and used for the
purpose of cost control”. The determination of suitable cost centres as well as analysis of cost
under cost centres is very helpful for periodical compari son and control of cost. In order to
obtain the cost of product or serv ice, expenses should be suitably segregated to cost centre. The
manager of a cost centre is held responsible for control of cost of his cost centre. The selection of
suitable cost centres or cost units for which costs are to be ascertained in an undertaking depends
upon a number of factors such as organization of a factory, condition of incidence of cost,
availability of information, requirements of costing and management policy regarding selecting a
method from various choices. Cost centre may be production cost centres operating cost centres
or process cost centres depending upon the situation and classifica tion. Cost centres are of two
types-Personal and Impersonal Cost Centre. A personal cost centre consists of person or group of
persons. An impersonal cost centre consists of a location or item of equipment or group of
equipments. In a manufacturing concern, the cost centres generally follow the pattern or layout
of the departments or sections of the factory and accordingly, there are two main types of cost
centres as below :
(i) Production Cost Centre: These centres are engaged in production work i.e engaged in
converting the raw material into finished product, for example Machine shop,
welding shops...etc
(ii) Service Cost Centre: These centres are ancillary to and render service to production
cost centres, for example Plant Maintenance, Administration...etc The number of cost
centres and the size of each vary from one undertaking to another and are dependent
upon the expenditure involved and the requirements of the management for the
purpose of control.

4.4 Cost Volume Profit Analysis. also known as Break Even Analysis

CVP analysis is the analysis of three variable viz. cost, volume and profit. Such analysis
explores the relationship existing amongst costs, revenue, activity level and resulting profit. It
aims at measuring variation of cost with profit.

4.41 Fixed Cost:

These are the costs which incurred for a period and which within certain output and turnover
limits, tend to be unaffected by fluctuations in the levels of activity (Output or turnover). For
example: Rent, insurance of factory building etc. remains the same for different levels of
production.

4.42: Variable Cost

These costs tend to vary with the volume of activity. Any increase in activity results in an
increase in the variable cost and vice versa. For example: Cost of direct labour, direct material,
etc.
 Figure 4.2: Graph of Fixed Cost

Figure 4.3: Graph of Variable Cost

4.43 Semi-Variable Cost :

These costs contain both fixed and variable components and thus partly affected by fluctuation in
the level of activity. Examples of semi variable costs are telephone bill, gas and electricity etc.

Figure 4.4: Graph of Semi Variable Cost

4.44 Cost-Volume-Profit Analysis CVP analysis:

Takes into account
- the total costs (fixed and variable)
- the total sales revenues - desired profits vis-a-vis the sales volume
It is used for forecasting or predicting how the changes in costs and sales volume affect profit. It
is also known as 'Break-Even Analysis'.
CVP analysis could be helpful in the following situations: Budget planning: for forecasting profit
by considering cost and profit relation, and volume of production volume. This will help in
determining the sales volume required to make a profit
- To make decisions regarding pricing and sales volume. Determining the sales mix of different
products, in what proportions each of the products can be sold. - Preparing flexible budget
considering costs at different levels of production.

4.45 Objectives of CVP Analysis

- Understand the interaction among
 Prices of products.
 Volume or level of activity.
 Per unit variable cost.
 Total fixed cost.
  Mix of product sold.

4.46: Assumptions of CVP Analysis

 Expenses can be classified as either variable or fixed.

 CVP relationships are linear over a wide range of production and sales.
 Sales prices, unit variable cost, and total fixed expenses will not vary within the relevant
range. Volume is the only cost driver.
 The relevant range of volume is specified.
 Inventory levels will be unchanged
 The sales mix remains unchanged during the period.

Calculations

Profit Equation and Contribution Margin

1. Profit = Sales -Total costs
2. Profit = Sales -Total variable costs - Total Fixed costs
3. Contribution margin = Total revenue – Total variable costs

Sales XX –
Variable Cost (XX)
Contribution XX
-Fixed Cost (XX)
Profit XX

Profit = (S-V)*Q – FC
Q = (FC + Expected Profit) / (S - VC)
Q is the no. of units required to be sold to obtain target profit.
S = Selling Price p.u.
VC = Variable cost p.u.
FC = Fixed Cost.

Example:
Suppose that Super Bikes wants to produce a new mountain bike called Hero1 and has forecast
the following information.
Price per bike = 800
Variable cost per bike = 300
Fixed costs related to bike production = 55,00,000
Target profit = 2,00,000
Estimated sales = 12,000 bikes
We determine the quantity of bikes needed for the target profit as follows:
Quantity = ( 55,00,000 + 2,00,000) / ( 800 - 300) = 11,400 bikes

4.47 Profit Volume Ratio (PV)

The contribution margin ratio (CMR) i.e. PV ratio is the percentage by which the selling price
(or revenue) per unit exceeds the variable cost per unit, or contribution margin as a percentage of
revenue.
Example For Hero1, we could use the forecast information about volume (12,000 bikes) to
determine the contribution margin ratio.
Total revenue = INR 800 * 12,000 = INR 96,00,000
Total variable cost = 300* 12,000 = INR 36,00,000
Total contribution margin = INR 9,600,000 – INR 3,600,000 = INR 6,000,000
Contribution margin ratio = 6,000,000 / 9,600,000 = 0.625

4.48 BEP analysis

Breakeven analysis is used to find the minimum level of production required. Evaluates both
fixed and variable costs. Uses:
1. To find a suitable product mix.
2. To find the sales required to reach a desired revenue.
3. The profits at certain price level and sales.

Figure 4.5: Cost Volume Profit (CVP) Graph or Break Even Analysis (BEA) Graph
4.49 Break Even Point (BEP)
A CVP analysis can be used to determine the BEP, or level of operating activity at which
revenues cover all fixed and variable costs, resulting in zero profit. In other words this is the
point where no profit or losses have been made.

4.491 Break even Applications

New Product decisions :

Enables to determine the sale volume required for a firm (or an individual product) to
breakeven, given expected sales price and expected costs.
Pricing decisions:
Enables to study the effect of changing price and volume relationship on total profits.
Modernizations or automation decisions:
Analysis the profit in implication of a modernization or automation programme.
Expansion Decisions :
studies the aggregate effect of a general expansion in production and sales.