Break - Even Analysis:

Break – Even Analysis involves the study of revenues and costs of a firm in
relation to its volume of sales. It specifically involves determination of that
volume at which the firm’s costs and revenues will be equal.
(OR)
Break-even analysis is a financial calculation that weighs the costs of a new
business, service or product against the unit sell price to determine the point
at which you will break even. In other words, it reveals the point at which you
will have sold enough units to cover all of your costs.
Break - Even Point:
Break – Even Point (BEP) is defined as that point of activity (sales
volume) at which the total revenues equals the total cost and the
net income is zero. It is also known as no profit, no loss point. It is
the point of zero profit.

(OR)
The break-even point is the point at which total cost and total
revenue are equal, meaning there is no loss or gain for your small
business. In other words, you've reached the level of production
at which the costs of production equals the revenues for a
product.
Components of Break-Even Analysis
 Fixed costs: These costs are also known as overhead costs. These costs
materialize once the financial activity of a business starts. The fixed prices
include taxes, salaries, rents, depreciation cost, labour cost, interests, energy
cost, etc.

 Variable costs: These costs fluctuate and will decrease or increase according
to the volume of the production. These costs include packaging cost, cost of
raw material, fuel, and other materials related to production.
Importance of Break-Even Analysis
 Manages the size of units to be sold: With the help of break-even analysis, the company or the
owner comes to know how many units need to be sold to cover the cost. The variable cost and
the selling price of an individual product and the total cost are required to evaluate the break-
even analysis.
 Budgeting and setting targets: Since the company or the owner knows at which point a
company can break-even, it is easy for them to fix a goal and set a budget for the firm
accordingly. This analysis can also be practised in establishing a realistic target for a company.
 Manage the margin of safety: In a financial breakdown, the sales of a company tend to decrease.
The break-even analysis helps the company to decide the least number of sales required to make
profits. With the margin of safety reports, the management can execute a high business decision.
 Monitors and controls cost: Companies’ profit margin can be affected by the fixed and variable
cost. Therefore, with break-even analysis, the management can detect if any effects are changing
the cost.
 Helps to design pricing strategy: The break-even point can be affected if there is any change in
the pricing of a product. For example, if the selling price is raised, then the quantity of the
product to be sold to break-even will be reduced. Similarly, if the selling price is reduced, then a
company needs to sell extra to break-even.
Uses of Break-Even Analysis
 New business: For a new venture, a break-even analysis is essential. It guides the
management with pricing strategy and is practical about the cost. This analysis also
gives an idea if the new business is productive.

 Manufacture new products: If an existing company is going to launch a new

product, then they still have to focus on a break-even analysis before starting and
see if the product adds necessary expenditure to the company.

 Change in business model: The break-even analysis works even if there is a change
in any business model like shifting from retail business to wholesale business. This
analysis will help the company to determine if the selling price of a product needs to
change.
Assumptions: -
1. It assumes that the costs are classified as fixed cost and variable cost, thus ignoring
the semi – variable cost.
2. All revenues are perfectly variable with the physical volume of production.
3. The sales price of a product is assumed to be constant.
4. It assumes constant rate of increase in variable cost.
5. There will be no improvement in technology and efficiency.
6. The volume of sales and the volume of production are equal.
7. There is no change in the input price.
8. In case of a multi – product firm, the product – mix should be stable.
9. Productivity of the worker will remain unchanged.
Limitations: -
1. It assumes price to remain constant.

2. It has limited use in case of multi – product firms.

3. No change in government policies cannot be there.

4. Availability of Cost – Volume – Profit data.

5. It does not take care of improved managerial efficiency and its impact on
production.
The break even point through mathematical method can be found out either by
i) Equation Method, or
ii ) Contribution Margin Technique.

Equation Method
We know,
Sales – Variable costs – Fixed cost = Profit (S -VC – FC = P)
Sales – Variable costs = Fixed costs + Profit (S - VC = FC + P)
Sales minus variable costs is called Contribution. (S - VC = C)
Contribution = Fixed costs + Profit (C = FC + P)
At break even point, profit is zero.
∴ Contribution = Fixed Costs (at break even point) or (SP -VC) Q = F

Where, SP is selling price, VC is the variable costs, F is a fixed costs and Q is

the number of units produced and sold. Look at the following illustration
how the breakeven point is to be calculated:
Illustration 1:
Calculate the break even point from the following information :
Selling price = Rs. 3 per unit
Variable cost = Rs. 2 per unit
Fixed cost = Rs. 90,000
Estimated sales for the period = 100,000 units or Rs. 300,000
Suppose the units to be produced and sold at break even point is Q,
then
Sales – Variable Costs = Contribution = Fixed Costs
3 Q – 2 Q = 90,000
Q = 90,000 units

When we produce and sell 90,000 units, then total sales revenue is Rs. 2,70,000
(90,000 units × Rs. 3 ) and total cost is Rs. 2,70,000, (VC Rs. 2 × 90000 units =
1,80,000 + F C Rs. 90,000)
Contribution Margins Technique:

Contribution per unit means difference between selling price and variable costs or
Contribution per unit = Selling price per unit – Variable Cost per unit
Total Contribution = Sales Revenue – Total Variable Costs

Break even point can be expressed in terms of units to be produced and sold or in terms
of value of goods. At break even point, we know
Profit /Volume Ratio (P/V ratio)
Total contribution divided by total
sales is called profit-volume ratio or
contribution ratio (P/V ratio). Break-
even point can be determined with
the help of P/V ratio.