Breakeven Analysis

Break-even is the point at which a product or service stops costing money to produce and sell, and starts generating a profit for your business. This means sales have reached sufficient volume to cover the variable and fixed costs of producing and distributing your product.

The Breakeven analysis is mostly used at the time of investing in new project and introducing new products. The organizer of this workshop must have seen Break even for this workshop.

Use Of Break Evenanalyses

Hospital or Hotel management would like to know sales point in terms of number of beds/ rooms, to recover fixed cost to reach at a breakeven point. ?The school owner would be interested in knowing minimum number of students to be admitted to reach at breakeven ?New branch of bank would need to know minimum deposits from customer ?On introduction of new products certain huge sales promotional expenses are planned in order to achieve planned sales. The management while deciding about approving expenditures would be interested to see cost / benefit analyses or minimum expected sales (break even) to be achieved to recover these expenses (disregarding the very ambitious sales budgets submitted by the sales and marketing team) FORMULA A) Breakeven point of output = (fixed cost) / (contribution per unit) Where, Contribution=selling cost – variable cost Fixed cost= Contribution -profit B) Breakeven point of Sales = 1. Fixed price x SP per unit Contribution per unit 2.

Fixed Cost x Total Sales Total Contribution BREAK EVEN GRAPH Uses of Breakeven Chart A breakeven chart can be used to show the effect of changes in any of the following profit factors:

• Volume of sales
• Variable expenses
• Fixed expenses
• Selling price

Profit Volume Ratio (P/V RATIO)

The ratio of contribution to sales is P/V ratio or C/S ratio. It is the contribution per rupee of sales and since the fixed cost remains constant in short term period, P/V ratio will also measure the rate of change of profit due to change in volume of sales.

The P/V ratio may be expressed as follows: P/V ratio = Sales – Marginal cost of sales = Contribution Sales Sales = Changes in contribution = Change in profit Changes in sales Change in sales A fundamental property of marginal costing system is that P/V ratio remains constant at different levels of activity. A change in fixed cost does not affect P/V ratio. The concept of P/V ratio helps in determining the following:

• Breakeven point Profit at any volume of sales
• Sales volume required to earn a desired quantum of profit
• Profitability of products
• Processes or departments the contribution can be increased by increasing the sales price or by reduction of variable costs.

Marginal Cost

A marginal cost is another term for a variable cost. The term ‘marginal cost’ is usually applied to the variable cost of a unit of product or service, whereas the term ‘variable cost’ is more commonly applied to resource costs, such as the cost of materials and labour hours.

Marginal costing is a form of management accounting based on the distinction between: a. the marginal costs of making selling goods or services, and b. fixed costs, which should be the same for a given period of time, regardless of the level of activity in the period. Suppose that a firm makes and sells a single product that has a marginal cost of ? 5 per unit and that sells for ? 9 per unit. For every additional unit of the product that is made and sold, the firm will incur an extra cost of ? 5 and receive income of ? 9. The net gain will be ? 4 per additional unit.

This net gain per unit, the difference between the sales price per unit and the marginal cost per unit, is called contribution. Contribution is a term meaning ‘making a contribution towards covering fixed costs and making a profit’. Before a firm can make a profit in any period, it must first of all cover its fixed costs. Breakeven is where total sales revenue for a period just covers fixed costs, leaving neither profit nor loss. For every unit sold in excess of the breakeven point, profit will increase by the amount of the contribution per unit LIMITATIONS OF BREAK EVEN ANALYSIS: It 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.

Break-even analysis is only a supply side (i. e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.

It assumes that fixed costs (FC) are constant. Although this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise.