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It is performed to identify the level of operations at which the entity has covered all costs but not yet earned any points It identifies the volume of activity at which total revenues equal total costs It presents minimum level of operations It indicates that profitable operations can only result when the level of activity exceeds the break-even point
Break even analysis in terms of physical units
It utilizes the contribution approach to compute net income, which splits costs into a fixed and variable classification It can be computed by dividing total fixed costs by the contribution margin provided by each unit BEA in units= Total fixed costs/Contribution margin per unit = FC/ S-VC
BEA in Sales Rupees
It identifies the amount of sales rupees required to cover all costs but generates no profit The method is to compute break-even in units and multiply the number of units by the sales price per unit It is equal to fixed costs divided by the contribution margin ratio BEP in sales rupees= FC/Contribution margin ratio
Variable cost per unit/ Sales price per unit OR Total sales-Total variable costs/ total sales . Contribution margin ratio= Sales price per unit.
BE for Multi Product Situations BEA can be performed for multiple products using either units of production or sales rupees by assuming that the company¶s sales mix will remain constant Sales mix refers to the ratio or relative combination of each product¶s sales to total sales. It is the composition of total sales broken down among various products or product lines .
BEA in units for multiple products It is used to compute a break-even points in units A market basket representing the average sales mix is developed The contribution provided by the basket is used to compute the number of baskets that must be sold to break-even The number of individual products required to fill the baskets at the break-even point is then determined .
the fixed costs are divided by the average contribution margin ratio The difference is in the level of aggregation in computing the average contribution margin ratio .BEA in Sales for multiple products It can be computed by using an average contribution margin ratio The average contribution ratio can be computed on a per unit basis or it can be developed from the income statement In both the cases.
the less steep the total revenue curve. Total revenue is determined by the price charged and the quantity sold ± again this will be determined by expected forecast sales initially. Break-Even Analysis TR TR TC The lower the price. these do not depend on output or sales. the firm will incur variable costs ± these vary directly with the amount produced Output/Sales . Initially a firm will VC incur fixed costs. FC Q1 The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC As output is generated.The Break-even point occurs where total revenue equals total costs ± the firm. in this example would have to sell Q1 to generate Costs/Revenue sufficient revenue to cover its costs.
Costs/Revenue Break-Even Analysis TR (p = £3) TR (p = £2) TC VC If the firm chose to set price higher than £2 (say £3) the TR curve would be steeper ± they would not have to sell as many units to break even FC Q2 Q1 Output/Sales .
Break-Even Analysis Costs/Revenue TR (p = £1) TR (p = £2) TC VC If the firm chose to set prices lower (say £1) it would need to sell more units before covering its costs FC Q1 Q3 Output/Sales .
Break-Even Analysis Costs/Revenue TR (p = £2) TC VC Profit Loss FC Q1 Output/Sales .
A higher price would lower the break even point and the margin of safety would widen Costs/Revenue Break-Even Analysis TR (p = £3) TR (p = £2) TC Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800. sales could fall by 800 units before a loss would be made VC Assume current sales at Q2 Margin of Safety FC Q3 Q1 Q2 Output/Sales .
Interest on debt rises each year ± FC rise therefore FC 1 FC Losses get bigger! TR VC Output/Sales .Costs/Revenue High initial FC.
service. and symbolic attributes designed to enhance buyers¶ want satisfaction .What is a Product? Product: bundle of physical.
Service: intangible task that satisfies consumer or business user needs Goods-services continuum: device Goodsthat helps marketers to visualize the differences and similarities between goods and services What are Goods and Services? .
.The Product Mix A company¶s assortment of product lines and individual offerings ± Product Width--the number of product lines offered. ± Product Depth--variations in each product that a firm markets in its mix. ± Product Length--the number of different products a firm sells.
and new product may extend the product life cycle ± Line extension: introduction of a new product that is closely related to other products in the firm¶s existing line . Product Mix Decisions ± A firm may lengthen or widen its product mix ± A Company may decide to add variations that will attract new users ± A product may be pruned or altered.
and decline stages . Product life cycle: progression of cycle products through introduction. maturity. growth.
financial losses are common due to heavy promotional and research-anddevelopment costs . Introduction Stage ± Firm works to stimulate demand for the new market entry ± Promotional campaigns stress features ± Additional promotions to intermediaries attempt to induce them to carry the product ± Although prices are typically high.
Growth Stage ± Sales volume rises rapidly ± Firm usually begins to realize substantial profits ± Success attracts competitors ± Firm may need to make improvements to the product ± Additional spending on promotion and distribution may be necessary .
Maturity Stage ± Industry sales continue to grow. but eventually reach a plateau ± Many competitors have entered the market. and profits began to decline ± Differences between competing products diminish ± Available supplies exceed industry demand for the first time ± Competition intensifies and heavy promotional outlays are common .
sometimes become losses ± Firms cut prices in a bid for the dwindling market ± Manufacturers gradually drop the declining items from their product lines . Decline Stage ± Innovations or shifts in consumer preferences cause an absolute decline in industry sales ± Industry profits fall -.
Extending the Product Life Cycle Marketers usually try to expand each stage of the life cycle for their products as long as possible Product life cycles can stretch indefinitely as a result of decisions designed to: ± Increase the frequency of use by current customers ± Increase the number of users for the product ± Find new uses ± Change package sizes. or product quality . labels.
Product Deletion Decisions Product lines must sometimes be pruned and marginal products eliminated This decision is typically faced during the late maturity and early declined stages of the product life cycle An unprofitable item may be continued in order to provide a complete line for customers .
.Make or Buy Decisions Some companies have complete vertical integration. Some others buy every thing and just assemble them. Make or buy decision is made after value analysis and mostly by the same people involved in value analysis. Most companies are some where between two extremes of this continuum. they manufacture all their parts.
or has diminishing capacity or changing demand . The make-or-buy decision is the act of making a strategic choice between producing an item internally (in-house) or buying it externally (from an outside supplier). The buy side of the decision also is referred to as outsourcing Make-or-buy decisions usually arise when a firm that has developed a product or part²or significantly modified a product or part²is having trouble with current suppliers.
Can item be purchased? No Make Can item be made? No Buy Is it cheaper to make? No Buy Is capital available? No Buy Is there better use of capital? No Make .
and access to technological innovations. . A company who chooses to make rather than buy is at risk of losing alternative sources. The two most important factors to consider in a make-or-buy decision are cost and the availability of production capacity. design flexibility.
Expertise .Quality considerations .Cost .The nature of the demand . Factors to be considered in make or buy decisions .Available capacity .
It is conducted at the strategic and operational level Variables considered at the strategic level include analysis of the future. competing firms. and market trends all have a strategic impact on the make-or-buy decision In their 2003 book ³World Class Supply Management´. and Stephen Starling present a rule of thumb for out-sourcing . Issues like government regulation. as well as the current environment. Donald Dobler. David Burt.
or within those the firm must develop to fulfill future plans. and (3) the item fits well within the firm's core competencies. . including customer perception of important product attributes. It prescribes that a firm outsource all items that do not fit one of the following three categories: (1) the item is critical to the success of the product. (2) the item requires specialized design and manufacturing skills or equipment. and the number of capable and reliable suppliers is extremely limited. .
Keong Leong. Make-or-buy decisions also occur at the operational level. suggest these considerations that favor making a part in-house: . and Keah-Choon Tan. Dobler.Cost considerations (less expensive to make the part) .Productive use of excess plant capacity to help absorb fixed overhead (using existing idle capacity) . as well as Joel Wisner. Analysis in separate texts by Burt. and Starling.Need to exert direct control over production and/or quality .Better quality control . G.Desire to integrate plant operations .
pride) ...Quantity too small to interest a supplier .Desire to maintain a stable workforce (in periods of declining sales) .Greater assurance of continual supply .No competent suppliers .Unreliable suppliers .Emotion (e. social or environmental reasons (union pressure) .Provision of a second source .g.Design secrecy is required to protect proprietary technology . and warehousing costs .Political.Control of lead time. transportation.
Indirect managerial control considerations .Small-volume requirements .Item not essential to the firm's strategy . Factors that may influence firms to buy a part externally include: .Brand preference .Suppliers' research and specialized know-how exceeds that of the buyer .Desire to maintain a multiple-source policy .Procurement and inventory considerations .Limited production facilities or insufficient capacity .Cost considerations (less expensive to buy the item) .Lack of expertise .
Incremental factory overhead costs .Incremental purchasing costs . Elements of the "make" analysis include: .Delivered purchased material costs .Any follow-on costs stemming from quality and related problems .Direct labor costs .Incremental managerial costs .Incremental capital costs .Incremental inventory-carrying costs .
Cost considerations for the "buy" analysis include: .Transportation costs .Any follow-on costs related to quality or service .Purchase price of the part .Incremental purchasing costs .Receiving and inspection costs .
The selling price is constant 4. The product-mix is stable in the case of a multiproduct firm 7. Factor price is constant . Average and marginal productivity of factors are constant 6. Assumptions of BEA 1. The cost function and the revenue function are linear 2. The total cost is divided into fixed and variable costs 3. The volume of sales and the volume of production are identical 5.
4. 3. . capital budgeting techniques. The main advantage is that it explains the relationship between cost. variable cost. It is most useful when used with partial budgeting. It can be extended to show how changes in fixed cost. commodity prices. The major benefits to use break even analysis is that it indicates the lowest amount of business activity necessary to prevent losses. volume and returns. production. 2. Managerial uses of BEA 1. revenues will effect profit levels and break even points.
5. It is useful in arriving at make or buy decision . 8. A break-even point defines when an investment will generate a positive return and can be determined graphically or with simple mathematics 6. Computes the volume of production at a given price necessary to cover all costs. Provides microscopic view of the profit structure of the firm 9. Computes the price necessary at a given level of production to cover all costs. 7.
..e. costs only) analysis.e.Limitations of BEA Break-even analysis is only a supply side (i. as it tells you nothing about what sales are actually likely to be for the product at these various prices. linearity) It assumes that the quantity of goods produced is equal to the quantity of goods sold (i. (i. there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period).e. at least in the range of likely quantities of sales. It assumes that fixed costs (FC) are constant It assumes average variable costs are constant per unit of output.
In multi-product companies.e. .. it assumes that the relative proportions of each product sold and produced are constant (i. the sales mix is constant). It assumes that all of the output is sold at the same price .often a business will have to lower its price in order to increase its sales.
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