Break-Even Analysis

It is the study of cost and sales revenue/sales volume

The break-even point (BEP) is that level of sales at which
total revenues would be equal to the total cost
The net income will be equal to zero. This is no-profit, no-
loss point
It is used to estimate the income of organization under
different working conditions or activity levels
It is a management tool to assist decision making in capacity
planning, selection of alternatives.

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 Break-Even Analysis
To evaluate an idea for a new product or service
To assess the performance of an existing one
determining the volume of sales at which the product
reaches BEP
The break even point is the volume at which total revenues
equal to total costs. Use of this technique is known as break-
even analysis.
Break-even analysis can also be used to compare production
methods by finding the volume at which two different
processes have equal total costs.

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 Break-Even Analysis-Assumptions

 All units of the goods produced are sold

 Behavior of cost is predictable: Fixed costs remain unchanged
for all levels of output & variable costs vary proportionately
with respect to volume. Hence behavior of costs is predictable
 The total variable cost is assumed to be varying proportionately
with the output.
 Unit selling price is constant
 Inventory changes are nil

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 Break-Even Analysis

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 Break-Even Analysis
Notations Used:
Q = Output in units
QBEP = Break-even Quantity in Units
F = Total Fixed costs in Rs.
𝐹
AFC = Average fixed costs = in Rs./Unit
𝑄
TVC = Total Variable costs, in Rs.
𝑇𝑉𝐶
V = Average Variable cost= , in Rs/Unit
𝑄

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 Break-Even Analysis
TC = Total costs = [F+TVC] in Rs
TR = Total Revenue = [p*Q] in Rs
p= Selling Price, Rs/Unit
𝑇𝑅
= , in Rs/Unit or Average Revenue.
𝑄

π = Profit, in Rs
ACM = Avg. contribution margin
= (p-v) Rs/Unit

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 MARGIN OF SAFETY

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 MARGIN OF SAFETY
• Margin of safety represents the difference between the
actual sales volume and the BEP sales volume
• At BEP, the company is able to recover its fixed costs &
variable costs
• If actual sales are more than BEP sales the company would
make a profit; greater margin of sales, greater would be
the profit.
• Margin of safety expressed in units or monetary terms or
as a %
Margin of Safety: (MS)
Margin of safety (MS) = (Qact – QBEP) Units (or) Rs
Margin of Safety in % = (Qact – QBEP)*100/ QBEP

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 Break-Even Analysis
BEP in terms of units of output:

𝑭
QB = Units
(𝒑−𝒗)
Where:

QB = Break-even quantity in Units

F = Fixed cost in Rs
p = Selling Price in Rs/Unit
v = Avg. V C (or) Unit V C Rs/Unit
(p-v) = Contribution Margin Rs/Unit

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 Break-Even Analysis

BEP in terms of Sales Value (Rs):

𝑭
QB-Sales = 𝒗 in Rs
𝟏−
𝒑
Where:
QB -sales = Break-even Sales in Rs
F = Fixed cost in Rs
p = Selling Price in Rs/Unit
(1-v/p) = Contribution margin ratio (or) Profit
𝑃
volume ratio (or) ( )𝑟𝑎𝑡𝑖𝑜
𝑉

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 Break-Even Analysis
BEP in percentage capacity:
% BEP = (QB/QMax)*100

Volume needed to attain target Profit (π):

(𝑭+𝝅)
Qact = in units
(𝒑−𝒗)
𝑭+𝝅
Qact-sales = 𝒗 in Rs
𝟏−
𝒑

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 Break-Even Analysis
Multi-product BEP: (Units & Sales Value (Rs)
Overall Break even quantity in units;

𝑭
QBEP-Overall = in Units
∑𝑾𝒊 𝑪𝑴𝒊
Where;
F = Fixed Costs in Rs
∑WiCMi = Weighted contribution margin
Wi = Proportion of product “i”, quantity wise in
the total sales, ∑Wi = 1.
CMi = Contribution margin of product “i”,
= [pi-vi] Rs/Unit
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 Break-Even Analysis
Overall break-even quantity in sales value:
𝑭
QBEP-Overall = 𝑷 in Rs
∑𝑾𝒊 𝑽 𝒓𝒂𝒕𝒊𝒐𝒊
Where;
F = Fixed costs in Rs
𝑷
∑Wi( )ratioi = Weighted contribution margin ratio
𝑽
Wi = Proportion of product “i”; Sales wise in the total
sales value,
∑ Wi = 1
𝑃
( ) ratio i = Contribution margin ratio of product “i”
𝑉
𝑣𝑖
= [1- ]
𝑝𝑖
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 Methods of Lowering BEP
1.Reduce Fixed cost from F to F’:
𝐹
QBEP= ;
(𝑝−𝑣)
𝐹′
Q’BEP =
(𝑝−𝑣)
𝑄′𝐵𝐸𝑃 𝐹 ′ /(𝑝−𝑣)
= ;
𝑄𝐵𝐸𝑃 𝐹/(𝑝−𝑣)
Therefore;
𝑭′
Q’BEP = QBEP *
𝑭

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 Methods of Lowering BEP
2. Reduce Unit Variable cost from V to V’:
𝐹
QBEP= ;
(𝑃−𝑉)
𝐹
Q’BEP =
(𝑃−𝑉′)
𝑄′𝐵𝐸𝑃 𝐹/(𝑃−𝑉 ′ )
= ;
𝑄𝐵𝐸𝑃 𝐹/(𝑃−𝑉)
Therefore;
(𝑷−𝑽)
Q’BEP = QBEP *
(𝑷−𝑽′ )

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 Methods of Lowering BEP
3.Increase selling price from P to P’:
𝑄′𝐵𝐸𝑃 𝐹/(𝑃′ −𝑉)
= ;
𝑄𝐵𝐸𝑃 𝐹/(𝑃−𝑉)

Therefore;
(𝑷−𝑽)
Q’BEP = QBEP *
(𝑷′ −𝑽)

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 Profit-Volume Chart

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 Profit-Volume Chart

 It is the graphical representation between profit & loss

 Fixed cost is marked negative quantity
 X-axis is represented by quantity
 Intersection of income line and quantity gives BEP
 Profit & fixed costs are plotted for corresponding sales volume & the points
are joined by a called Income line
 Slope of the income line is called (P/V) ratio & is given by:

𝑃 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 𝐹 (𝑝−𝑣) 𝑣

( )𝑟𝑎𝑡𝑖𝑜 = = = = (1- )
𝑉 𝑉𝑜𝑙𝑢𝑚𝑒 𝑎𝑡 𝐵𝐸𝑃 𝑝∗𝑄𝐵𝐸𝑃 𝑝 𝑝

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