What is a Break-Even Analysis?

A break-even analysis is a financial tool which helps you to determine at what stage your company, or a
new service or a product, will be profitable. In other words, it’s a financial calculation for determining the
number of products or services a company should sell to cover its costs (particularly fixed costs). Break-
even is a situation where you are neither making money nor losing money, but all your costs have been
covered.
Break-even analysis is useful in studying the relation between the variable cost, fixed cost and revenue.
Generally, a company with low fixed costs will have a low break-even point of sale. For an example, a
company has a fixed cost of Rs.0 (zero) will automatically have broken even upon the first sale of its
product.

Components of Break Even Analysis

Fixed costs
Fixed costs are also called as the overhead cost. These overhead costs occur after the decision to start an
economic activity is taken and these costs are directly related to the level of production, but not the quantity
of production. Fixed costs include (but are not limited to) interest, taxes, salaries, rent, depreciation costs,
labour costs, energy costs etc. These costs are fixed no matter how much you sell.
Variable costs
Variable costs are costs that will increase or decrease in direct relation to the production volume. These cost
include cost of raw material, packaging cost, fuel and other costs that are directly related to the production.

Calculation of Break-Even Analysis

The basic formula for break-even analysis is driven by dividing the total fixed costs of production by the
contribution per unit (price per unit less the variable costs).

When is Break even analysis used?

Starting a new business: If you wish to start a new business, a break-even analysis is a must. Not only it
helps you in deciding, whether the idea of starting a new is viable, but it will force you to be realistic about
the costs, as well as guide you about the pricing strategy.
Creating a new product: In the case of an existing business, you should still do a break-even analysis
before launching a new product—particularly if such a product is going to add a significant expenditure.
Changing the business model: If you are about to the change your business model, like, switching from
wholesale business to retail business, you should do a break-even analysis. The costs could change
considerably and this will help you to figure out the selling prices need to change too.

Breakeven analysis is useful for the following reasons:

 It helps to determine remaining/unused capacity of the concern once the breakeven is

reached. This will help to show the maximum profit on a particular product/service that can be generated.
 It helps to determine the impact on profit on changing to automation from manual (a fixed
cost replaces a variable cost).
 It helps to determine the change in profits if the price of a product is altered.
 It helps to determine the amount of losses that could be sustained if there is a sales downturn.
 Additionally, break-even analysis is very useful for knowing the overall ability of a business to generate a
profit. In the case of a company whose breakeven point is near to the maximum sales level, this signifies
that it is nearly impractical for the business to earn a profit even under the best of circumstances.
Therefore, it’s the management responsibility to monitor the breakeven point constantly. This monitoring
certainly reduces the breakeven point whenever possible.

Ways to monitor Break even point

 Pricing analysis: Minimize or eliminate the use of coupons or other price reductions offers,
since such promotional strategies increase the breakeven point.
 Technology analysis: Implementing any technology that can enhance the business
efficiency, thus increasing capacity with no extra cost.
 Cost analysis: Reviewing all fixed costs constantly to verify if any can be eliminated can
surely help. Also, review the total variable costs to see if they can be eliminated. This analysis will increase
the margin and reduce the breakeven point.
 Margin analysis: Push sales of the highest-margin (high contribution earning) items and pay
close attention to product margins, thus reducing the breakeven point.
 Outsourcing: If an activity consists of a fixed cost, try to outsource such activity (whenever
possible), which reduces the breakeven point.

Benefits of Break-even analysis

 Catch missing expenses: When you’re thinking about a new business, it’s very much possible that you
may forget about few expenses. Therefore, if you do a break-even analysis you have to review all your
financial commitments to figure out your break-even point. This analysis certainly restricts the number of
surprises down the road.
 Set revenue targets: Once the break-even analysis is complete, you will get to know how much you
need to sell to be profitable. This will help you and your sales team to set more concrete sales goals.
 Make smarter decisions: Entrepreneurs often take decisions in relation to their business based on
emotion. Emotion is important i.e. how you feel, though it’s not enough. In order to be a successful
entrepreneur, your decisions should be based on facts.
 Fund your business: This analysis is a key component in any business plan. It’s generally a
requirement if you want outsiders to fund your business. In order to fund your business, you have to prove
that your plan is viable. Furthermore, if the analysis looks good, you will be comfortable enough to take the
burden of various ways of financing.
 Better Pricing: Finding the break-even point will help in pricing the products better. This tool is highly
used for providing the best price of a product that can fetch maximum profit without increasing the existing
price.
 Cover fixed costs: Doing a break-even analysis helps in covering all fixed cost.

PROJECT APPRAISAL

Definition
Project appraisal is the structured process of assessing the viability of a project or proposal.
It involves calculating the feasibility of the project before committing resources to it. It is a
 tool that company’s use for choosing the best project that would help them to attain their
goal. Project appraisal often involves making comparison between various options and this
done by making use of any decision technique or economic appraisal technique.
Project appraisal is a tool which is also used by companies to review the projects completed
by it. This is done to know the effect of each project on the company. This means that the
project appraisal is done to know, how much the company has invested on the project and in
return how much it is gaining from it.

Project Appraisal is a consistent process of reviewing a given project and evaluating its content to approve
or reject this project, through analyzing the problem or need to be addressed by the project, generating
solution options (alternatives) for solving the problem, selecting the most feasible option, conducting a
feasibility analysis of that option, creating the solution statement, and identifying all people and
organizations concerned with or affected by the project and its expected outcomes. It is an attempt to justify
the project through analysis, which is a way to determine project feasibility and cost-effectiveness.
Project appraisal follows the project formulation phase resulting in the preparation of feasibility report (FR). The
main objective of project appraisal is to ultimately decide whether the project proposed/sponsored in the FR has to
be accepted for Capital Investment, or be rejected. The initial appraisal of the project sponsored also aims at, if need
be, recommending the steps or ways in which the project can be redesigned or reformulated with a view to better
technical, financial, commercial and economic viabilities; also mitigate or minimize any adverse on negative
environmental impact. Thus, project appraisal is an essential tool for judicious investment decision-making, full and
complete data and information need to be documented/presented, and analyzed in the FR so as to facilitate the
appraisal authorities to carry out:
(i) Demand analysis to establish convincingly the need for the project,
(ii) (ii) Check on optimal location,
(iii) (iii) Technical analysis to determine whether the specification of technical parameters are
sound and realistic,
(iv) (iv) Financial analysis to assess whether the project proposal is financially viable,
(v) (v) Commercial analysis to establish the soundness of product or service specifications,
marketing plans, organization structure (both project and for operation),
(vi) (vi) Socio-economic analysis to determine whether the project is worthwhile to implement
from the point of view of the nation that is society at large and the economy as a whole, and
(vii) (vii) Environment and physiographical and ecological thresholds analysis which is concerned
with the identification of these constraints, and make the evaluation of chances of success (or
otherwise) which the project may have to face (these constraints). Internal consistency and
external compatibility are two basic attributes of a viable project.
Development oriented administration and forward looking management may have under
consideration, at any juncture or time, a number and variety of projects, resources being limited, a
choice has to be made. Project appraisal is warranted to assess the material attributes of an
investment proposition and to confirm the implications the project will pose for the sponsoring
authorities (system) as well as for systems with which it will have to co-exist after its
implementation

Capital Rationing
Capital rationing is essentially a management approach to allocating available funds across
multiple investment opportunities, increasing a company's bottom line. The company accepts
the combination of projects with the highest total net present value (NPV). The number one
goal of capital rationing is to ensure that a company does not over-invest in assets. Without
adequate rationing, a company might start realizing decreasingly low returns on investments
and may even face financial insolvency.

Capital rationing is a situation where a constraint or budget ceiling is placed on the total size
of capital expenditures during a particular period. Often firms draw up their capital budget
under the assumption that the availability of financial resources is limited.

Capital rationing refers to the selection of the investment proposals in a situation of constraint
on availability of capital funds, to maximize the wealth of the company by selecting those
projects which will maximize overall NPV of the concern.

In capital rationing situation a company may have to forego some of the projects whose IRR
is above the overall cost of the firm due to ceiling on budget allocation for the projects which
are eligible for capital investment. Capital rationing refers to a situation where a company
cannot undertake all positive NPV projects it has identified because of shortage of capital.

Under this situation, a decision maker is compelled to reject some of the viable projects
having positive net present value because of shortage of funds. It is known as a situation
involving capital rationing.

Types of Capital Rationing

Examples of Capital Rationing

For example, suppose ABC Corp. has a cost of capital of 10% but that the company has
undertaken too many projects, many of which are incomplete. This causes the company's
actual return on investment to drop well below the 10% level. As a result, management
decides to place a cap on the number of new projects by raising the cost of capital for these
new projects to 15%. Starting fewer new projects would give the company more time and
resources to complete existing projects.