Break-Even Analysis

Simplified for Better

Understanding

1
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 Definition of Important factors
Marginal Costing:
Marginal costing necessiates analysis of
costs into fixed and variable. It has been
designed to help the management to have
a clear perspective on the effect of these
two types of costs on the profitability
margin and sales volume .

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Cost-Volume-Profit Relationship
This CVP( cost-volume-profit) analysis
pertains to management accounting
where the results can be interpreted to
know the
1. Actual cost of production under different
circumstances
2. What has to be the volume of
production?
3. What profit can be earned?
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 Contribution

Contribution is the difference between sales and

the variable cost and referred to as “Gross
margin.”
It is visualised as some sort of fund or pool out
of which all fixed costs are to be met and to
which each product has to contribute its share.
The difference between contribution and fixed
cost is either profit or loss as the case may be.

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 Variable or Marginal Cost
Statement
Sales-Variable cost= Contribution
Contribution-Fixed Cost= Profit
Variable Cost Statement
Sales Revenue xxxx
Direct Materials xxxx
Direct Labour xxxx
Variable Overhead xxxx
Variable Costs (xxxx)
Contribution xxxx
Fixed Overhead (xxxx)
Profit xxxx
(- )Read as minus symbol
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 Concept of Contribution
The concept of contribution is useful in

Fixation of selling prices

Determination of break-even point
Selection of product-mix for profit
maximisation
Ascertainment of profitability of products,
departments etc.
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 Contribution Margin Ratio
The contribution margin is also useful for
determining the impact on profits of changes in
sales. In particular, it can be used to estimate
the decline in profits if sales drops, and so is a
standard tool in the formulation of budgets.
Formula: To calculate the contribution margin
ratio, divide the contribution margin by sales.
The formula is:
Contribution margin
Sales
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 How to Calculate Con.Margin
Example:
Rs.
Revenue 10,00,000
Variable expenses 4,00,000
----------------
Contribution margin 6,00,000
Fixed expenses 6,60,000
Net loss 60,000

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 Break-Even Analysis
In its narrow sense, it is that point where
Total Revenues=Total Expenses, i.e., the
point of zero profit.

In a broader sense, it denotes a system of

analysis that can be used to determine the
probable profit at any level of operations.

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Definition of Break-Even Point
At the breakeven point of a business,
income is equal to expense and therefore
there is no gain or loss.

It is the starting point from which an

increase in sales or a reduction in costs
generates a gain and a reduction in sales
or an increase in costs generates a loss.

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 Why to calculate BE Point
The breakeven point is an important reference
point that enters into planning and carrying out
business activities.
A clear understanding of the level of sales
needed to cover all costs helps you to know
1. How many units you must produce in the case
of a manufacturing business
2. How many units you need to purchase and sell,
in the case of a merchandising business.
3. In a services business, the breakeven point
indicates the number of billable hours you must
work in order to cover your costs.
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 Assumptions of CVP Analysis
1. Costs are differentiated into fixed and
variable components.
2. Fixed cost remains constant.
3. Variable costs as the name indicates
vary in proportion with the volume.
4. Selling price does not change with
volume.
5. There is only one product or, in the case
of multiple products, sales mix remains
constant.
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 Assumptions of CVP Analysis
6. There will be no change in the general
price level.
7. Productivity per worker remains
unchanged.
8. There is synchronisation between
production and sales.
9. The efficiency of plant can be predicted.
10. The principle of cost variability is valid.

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 What is fixed cost
Fixed cost is invariable and has to be borne by the company regardless of
the level of sales.

Examples:

1. The cost to rent an office, shop, warehouse, factory, or other facilities

2. Base salaries and wages of employees; employee benefit plans,

maintenance contracts; contracts for cleaning and security services;
advertising contracts; insurance

3. Base costs of utilities such as electricity, gas, water, and sewage

4. Base costs of telephone land lines or cellular telephone; Internet connection;

the monthly cost of a domain and website; real and personal property taxes;
licenses and permits; depreciation and amortization; and interest and other
debt service expenses.

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 What is variable cost
The costs that are incurred in proportion to the level of
sales.
Examples:
1. Raw materials and supplies
2. Freight
3. Rental of machinery, equipment, and tools for specific
jobs
4. Fuel
5. Employee overtime pay; temporary contract labor;
repairs and maintenance; office supplies; telephone
calls; travel expenses; and sales commissions.

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 What is Semi-variable cost
The costs that possess both the
characteristics of fixed and variable may
be termed as semi-variable costs or semi-
variable over-heads.
For example electricity can be considered
as a fixed cost when it is utilised to
illuminate all the facilities in a plant and it
also becomes variable when the level of
operation increases to produce more
units.
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 What is Angle of Incidence
The angle at which the sales line cuts the
cost line.Any organisation would want this
angle to be wide and large as it indicates
more quantum of profit where all the fixed
over-heads are absorbed.
A narrrow angle also covers the fixed-
over-heads but still the profit margin is low
as compared to the former.

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 What is Margin of Safety

When the volume of sales exceeds the

break-even point, that area is called the
margin of safety.
It is important that there should be a
reasonable margin of safety. A low margin
indicates high fixed over-heads and
reduced activity which is not enough to
absorb the fixed costs and accrue profit.

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P/V Ratio or Profit-Volume Ratio
P/V ratio plays a very important role in all break-even point
determination as it indicates the relationship between contribution
and turn-over.

P/V ratio= Contribution

Sales
(or)
Sales - Variable cost
Sales
(or)
Sales= Contribution
P/V ratio
(or)
Contribution= Sales * P/V ratio

This is basically expressed in percentage %

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 Calculation of BE point
Break-even point= Fixed cost
P/V ratio
This formula is derived from the basic formula of break-even point
which is:
1. Fixed cost*Sales
Sales-Variable expenses (or)
2. Fixed costs / Sales-Variable expenses
Sales (or)
3. Fixed costs/ P/V ratio (or)
4. Fixed costs
P/V ratio (or)
5. Fixed Cots* 1
P/V ratio

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Break Even Graph

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Contribution Graph

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Profit and Loss

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 PROBLEMS
1. Find the BEP of production in terms of unit and in terms of value if the price of the product
is Rs 250 per unit; variable cost is Rs 150 per unit and the fixed cost is Rs 1,50,000.
Solution

In terms of unit:

BEP = FC/(SP – VC)

= 1,50,000/(250 – 150) =1,500 units

In terms of value:

BEP = FC/MC%
MC% = (SP – VC)/SP
= Rs (250 – 150)/ 250 = 0.40 = 40%
= Rs 1,50,000/0.40 = Rs 3,75,000

2. If the product’s demand is price-inelastic, the firm raises the price of the product from Rs
250 to Rs 300 with the same variable cost of Rs 150 and the unchanged fixed cost of Rs
1,50,000. Will the BEP change from that when it remains unchanged?
Solution
BEP with an increase in SP:
Rs 1,50,000/(300 – 150) = 1,000 units

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