BREAK EVEN ANALYSIS

Profit maximization can be recognized as the most important goal of any

firm. Since profit earning is one of the important objectives of any company,
profit cannot be left to chance or luck. A proper planning and control of
profit is of utmost importance to the organization. There are mainly two
techniques which are applied for profit planning and control:

 Break even analysis

 Ratio analysis

Break even analysis reveals the relationship between the volume and cost of
production on the one hand, and the revenue and profits obtained from the
sales on the other. A break even analysis indicates at what level costs and
revenue are in equilibrium.

Break even point: “The break even point is that point of activity (sales
volume) where total revenues and total expenses are equal. It is the point of
zero-profit” (Horngren). In other words, break even point is that specific
level of activity or volume of sales where the firm breaks even, i.e. the total
cost equals total revenue. It is, therefore, a point where losses cease to occur
while profits have not yet begun. The break even point may be taken as the
one indicating the minimum level of production / sales which the company
has to undertake in order to be economically viable.

Assumptions of Break-even analysis:

1. The costs can be classified into fixed and variable costs, thus ignoring
semi-variable costs.
2. Sale price of the product is assumed constant, thus giving linearity
property to total revenue curve.
3. It assumes constant rate of increase in variable cost, thereby imparting
linearity to total cost curve.
4. It assumes no improvement in technology and labour efficiency.
5. Changes in input prices are also ruled out.
6. Break-even analysis also assumes that the production and sales are
synchronized, in the sense that there is no addition or subtraction from
inventory.
Managerial Applications of the Break-Even Concept

1. Choice of Production Process – Both at the planning and expansion

stages a firm has tom decide about the most economical production
process. Break even analysis comes handy in case of the decision on a
choice of technique of production.
2. Estimating Profit at given Sales Volume – The break even equation can
be adapted to provide a means of estimating profit and loss at different
volumes.
3. Estimating Sales Volume required to produce desired profits – The
break even equation can also be adapted to provide a method for
determining the sales volume necessary to provide a desired profit.
4. Finding sales volume required to meet proposed expenditure –
Occasions may arise when a firm needs to know the additional sales
volume required to cover a contemplated increase in expenditure. Break
even analysis helps in such cases also.
5. Plant Expansion Decisions – Break even analysis may be utilized to
reveal the effect of an actual or proposed change in operating
conditions.
6. Plant Shut down decisions
7. Determining Safety margins – Safety margins are defined as the extent
to which the firm can let its sales decline before it encounters losses.
8. Changes in prices – Whether to increase or decrease the price of the
products
9. To analyze the change in costs
10.Decisions regarding changes in capacity
11.Choosing a product mix
12.Decisions regarding dropping or adding a product
13.Make or buy decisions
14.Advertising decision and decisions of promotion mix