Break-Even Analysis

 Break­even point is the level of sales at which profit is zero.  At breakeven point total sales are equal to total cost (variable + fixed).

 . It can be expressed either in sales units or Sales Taka amount.

 .The process of finding the break- even point is called break- even analysis

 

 Advantages of Break-even - analysis:

 

Following are some of the main advantages of breakeven analysis:

 

1. It explains the relationship between cost, production, volume and returns.

 

2. It can be extended to show how changes in fixed cost, variable cost, commodity prices, and revenues   will effect profit levels and break even points. Break even analysis is most useful when used with partial budgeting, capital budgeting techniques.

 

3. The major benefits to use break even analysis is that it indicates the lowest amount of business activity necessary to prevent losses.

Limitations:

 

Break even analysis is best suited to the analysis of one product at a time. It may be difficult to classify a cost as all variable or all fixed; and there may be a tendency to continue to use a break even analysis after the cost and income functions have changed.

 

Three approaches to “break –even analysis”

 1. Contribution Margin Approach,

 2.  Equation technique

 3. Graphic presentation:  Break-even chart

Contribution Margin:  The  excess  of  unit selling price over  unit variable cost is called  Contribution  Margin. Suppose, Unit selling price Tk. 500 and Unit variable cost Tk300, now Contribution Margin pet unit is –

 

Unit selling price – Unit Variable cost =  Unit  Contribution Margin

 

= Tk 500  - Tk 300 = Tk 200

 Under this method total fixed cost is divided by unit contribution margin. The resulting figure is number of units to be sold to break-even (no profit, no loss).

 Example:

We can use the following data to calculate break-even point.

 

 Sales price per unit     = TK.500 variable cost per unit  =  Tk.300

Total fixed expenses  =  TK.70,000

 Required:  Calculate break-even point using contribution margin method.

 Solution: Break-even point in units = Fixed expenses / Unit contribution margin

 

Tk.70,000 / TK.200*

 

350 Units

 

*TK.500 (Sales) – Tk 300 (Variable exp.)

 

Break even point in sales:

 

350 Units × Tk.500 Per unit

 

= Tk.1,75,000

Equation method and contribution margin methods are equivalent. Contribution margin method is actually a shortcut conversion of equation method.

 2 . Equation Method:

 Profit = Sales - (Variable expenses + Fixed expenses)

 or

 Sales = Variable expenses + Fixed expenses + Profit

 When break-even point is calculated using above equation profit is taken as zero because break-even is that level of sales where sales are equal to total cost (variable + fixed) and profit is zero.

 Example:

We can use the following data to calculate break-even point.

 Sales price per unit    = Tk. 500 variable cost per unit  = Tk. 300

Total fixed expenses  = Tk. 70,000

 Required: Calculate break-even point using equation method.

  Solution:

 Sales = Variable expenses + Fixed expenses + Profit Tk.500 Q* = Tk.300 Q* + Tk.70,000 + Tk.0** Tk.200

Q = Tk.70,000 

Q = Tk.70,000 ¸  Tk.200

  Q = 350 Units

3.  Break-Even- Chart .  The technique of break-even-analysis can be easy with the help of a graph. Graphical representation of break-even- point (cost volume profit) is known as the break-even chart. The chart shows the amount of fixed, variable costs and the sales revenue at different volumes of operation. The chart is also used for determining the break-even-point. The break-even-point indicates the volume of activity  where  revenue  exactly  equals  total  costs,  both  fixed  and variable. Thus , it indicates the sales volume at which operations ‘break- even’. At sales level below the break-even –point operations will result in a loss and above the point they will contribute profits.

3.  Margin of Safety: The excess of actual sales  over the break -even sales is called Margin of safety .The margin of safety is another relationship that may be calculated from CVP analysis.CVP analysis also help managers assess risk by providing a measure of the margin of safety. It shows how far sales can fall below the planned level of sales before loss occur. It compares the level of planned sales with the break- even point. The larger the margin of safety, the less likely it is that the company will have an operating loss, that is, operate below break-\even point. A small margin of safety indicate a more risky situation.

 

-     Margin of Safety Ratio =  Actual sales - Break-even  sales

                                                                                      Actual sales        

 

-     Symbolically,  M/S ratio =  (AS – BES) ÷ AS