BREAK EVEN POINT & ANALYSIS

BREAK EVEN POINT & ANALYSISBREAK EVEN POINT & ANALYSIS

ByBy

K GOWTHAM KUMAR.K GOWTHAM KUMAR.

DEFINITIONDEFINITION

The break even point is the The break even point is the point where the gains equal point where the gains equal the losses. The point defines the losses. The point defines when an investment will when an investment will generate a positive return. generate a positive return. The point where sales or The point where sales or revenues equal expenses. revenues equal expenses. The point where total costs The point where total costs equal total revenues. There is equal total revenues. There is no profit made or loss no profit made or loss incurred at the break even incurred at the break even point. It is the lower limit of point. It is the lower limit of profit when prices are set and profit when prices are set and margins are determined.margins are determined.

DEFINITIONDEFINITION

At this point the income of the business At this point the income of the business exactly equals its expenditure. If exactly equals its expenditure. If production is enhanced beyond this level, production is enhanced beyond this level, profit shall accrue to the business and if it profit shall accrue to the business and if it is decreased from this level, loss shall be is decreased from this level, loss shall be suffered by the business.suffered by the business.

FORMULAFORMULA Break even point (of output)Break even point (of output)

= (fixed cost) / (contribution per unit) = (fixed cost) / (contribution per unit)

Where,Where,

Contribution=selling cost-variable costContribution=selling cost-variable cost

Fixed cost= Contribution- profitFixed cost= Contribution- profit

FORMULAFORMULA

Break even point of Sales=Break even point of Sales=

1. 1. Fixed priceFixed price x SP per unit x SP per unit

Contribution per unitContribution per unit

2.2. Fixed CostFixed Cost x Total Sales x Total Sales

Total ContributionTotal Contribution

CALCULATION OF THE BREAK EVEN CALCULATION OF THE BREAK EVEN POINTPOINT

VARIABLE COST- VARIABLE COST- They are directly related to the volume of sales: that is these cost They are directly related to the volume of sales: that is these cost

increase in proportion to the increase in sales and vice versa.increase in proportion to the increase in sales and vice versa.

FIXED COST -FIXED COST - Fixed costs continue regardless of how much you can sell or not sell, Fixed costs continue regardless of how much you can sell or not sell,

and can be made up of such expenses as rent, wages, telephone account and and can be made up of such expenses as rent, wages, telephone account and insurance. These cost can be estimated by using last years figure as a basis, insurance. These cost can be estimated by using last years figure as a basis, because they typically do not change.because they typically do not change.

Formula= Formula= FIXED COSTFIXED COST

VARIABLE COSTSVARIABLE COSTS

At break even point, the desired profit is zero. At break even point, the desired profit is zero. In case the volume of output or sales is to be In case the volume of output or sales is to be computed for a desired profit, the amount of computed for a desired profit, the amount of desired profit should be added to fixed cost is desired profit should be added to fixed cost is the formula given above.the formula given above.

Units for a desired profit= Units for a desired profit=

Fixed cost+ desired profitFixed cost+ desired profit

Contribution per unitContribution per unit

Sales for a desired profit=Sales for a desired profit= (Fixed cost + Desired profit)(Fixed cost + Desired profit)

(P/V Ratio)(P/V Ratio)

Where as,Where as, P/V ratio= P/V ratio= Contribution per unitContribution per unit Selling price per unitSelling price per unit = = Total contributionTotal contribution Total salesTotal sales

CASH BREAK EVEN POINTCASH BREAK EVEN POINT

It is the point where cash breaks even i.e. the It is the point where cash breaks even i.e. the volume of sales where cash realization on volume of sales where cash realization on account of sales will be sufficient to meet the account of sales will be sufficient to meet the immediate cash liabilities.immediate cash liabilities.

The label of activities where the total costs The label of activities where the total costs under two alternatives are sameunder two alternatives are same

While calculating this point cash fixed costs While calculating this point cash fixed costs (i.e. excluding fixed share of depreciation and (i.e. excluding fixed share of depreciation and deferred expenses) and cash contribution (i.e. deferred expenses) and cash contribution (i.e. after making adjustments for variable share of after making adjustments for variable share of depreciation etc.) are considered. depreciation etc.) are considered.

The point helps the management in The point helps the management in determining the level of activities below determining the level of activities below which there are chances of insolvency on which there are chances of insolvency on account of the firms inability to meet the account of the firms inability to meet the cash obligation unless alternatives are cash obligation unless alternatives are made.made.

FORMULA FOR CASH BREAK EVEN POINTFORMULA FOR CASH BREAK EVEN POINT

Cash break even point (in units) = Cash break even point (in units) = (Cash fixed cost) / (cash contribution per unit)(Cash fixed cost) / (cash contribution per unit)

Cash break even point (in sales Rs.) =Cash break even point (in sales Rs.) =

(Cash fixed cost) / (cash contribution per (Cash fixed cost) / (cash contribution per unit) x selling price per unit unit) x selling price per unit

BREAK EVEN ANALYSISBREAK EVEN ANALYSIS

It refers to the ascertainment of level of operations It refers to the ascertainment of level of operations where total revenue equals to total costs.where total revenue equals to total costs.

Analytical tool to determine probable level of operation.Analytical tool to determine probable level of operation. Method of studying the relationship among sales, Method of studying the relationship among sales,

revenue, variable cost, fixed cost to determine the level revenue, variable cost, fixed cost to determine the level of operation at which all the costs are equal to the of operation at which all the costs are equal to the sales revenue and there is no profit and no loss sales revenue and there is no profit and no loss situation.situation.

Important techniques is profit planning and managerial Important techniques is profit planning and managerial decision making.decision making.

DEFINATIONS USED IN BREAK DEFINATIONS USED IN BREAK EVEN POINT-EVEN POINT-

Fixed Cost:Fixed Cost:The sum of all costs required to produce the first unit of a The sum of all costs required to produce the first unit of a product. This amount does not vary as production product. This amount does not vary as production increases or decreases, until new capital expenditures increases or decreases, until new capital expenditures are needed. are needed.

Variable Unit Cost:Variable Unit Cost:Costs that vary directly with the production of one Costs that vary directly with the production of one additional unit. additional unit.

Expected Unit Sales:Expected Unit Sales:Number of units of the product projected to be sold over Number of units of the product projected to be sold over a specific period of time. a specific period of time.

Unit Price:Unit Price:The amount of money charged to the customer for each The amount of money charged to the customer for each unit of a product or service. unit of a product or service.

DEFINATIONS CONTDEFINATIONS CONT

Total Variable Cost:Total Variable Cost:The product of expected unit sales and variable unit cost. The product of expected unit sales and variable unit cost. (Expected Unit Sales * Variable Unit Cost )(Expected Unit Sales * Variable Unit Cost )

Total Cost:Total Cost:The sum of the fixed cost and total variable cost for any given The sum of the fixed cost and total variable cost for any given level of production. level of production. (Fixed Cost + Total Variable Cost )(Fixed Cost + Total Variable Cost )

Total Revenue:Total Revenue:The product of expected unit sales and unit price.The product of expected unit sales and unit price. (Expected Unit Sales * Unit Price )(Expected Unit Sales * Unit Price )

Profit (or Loss):Profit (or Loss):The monetary gain (or loss) resulting from revenues after The monetary gain (or loss) resulting from revenues after subtracting all associated costs. subtracting all associated costs. (Total Revenue - Total Costs)(Total Revenue - Total Costs)

DEPENDENCEDEPENDENCE

Break even analysis depends on the following variables:Break even analysis depends on the following variables: The fixed production costs for a product. The fixed production costs for a product. The variable production costs for a product. The variable production costs for a product. The product's unit price. The product's unit price. The product's expected unit sales [sometimes called projected The product's expected unit sales [sometimes called projected

sales.]sales.] On the surface, break-even analysis is a tool to calculate at which On the surface, break-even analysis is a tool to calculate at which

sales volume the variable and fixed costs of producing your sales volume the variable and fixed costs of producing your product will be recovered. Another way to look at it is that the product will be recovered. Another way to look at it is that the break-even point is the point at which your product stops costing break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for you money to produce and sell, and starts to generate a profit for your company. your company.

It can also use break even analysis to solve managerial problems.It can also use break even analysis to solve managerial problems.

ADVANTAGEADVANTAGE

It is cheap to carry out and it can show It is cheap to carry out and it can show the profits/losses at varying levels of the profits/losses at varying levels of output. output.

It provides a simple picture of a business It provides a simple picture of a business - a new business will often have to - a new business will often have to present a break-even analysis to its bank present a break-even analysis to its bank in order to get a loan. in order to get a loan.

LIMITATIONSLIMITATIONS

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

It assumes that fixed costs (FC) are constant It assumes that fixed costs (FC) are constant It assumes average variable costs are constant per unit of output, It assumes average variable costs are constant per unit of output,

at least in the range of likely quantities of sales. (at least in the range of likely quantities of sales. ( i.e.i.e. linearity) linearity) It assumes that the quantity of goods produced is equal to the It assumes that the quantity of goods produced is equal to the

quantity of goods sold (i.e., there is no change in the quantity of quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period). quantity of goods held in inventory at the end of the period).

In multi-product companies, it assumes that the relative In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (proportions of each product sold and produced are constant ( i.e.i.e., , the sales mix is constant). the sales mix is constant).