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Unit 5 Break Even Analysis

Break Even Analysis examines the relationship between cost, volume of production, and profit, focusing on the point where neither profit nor loss occurs, known as the Break Even Point. It can be conducted using algebraic or graphical methods, with the latter being more common, and is essential for determining necessary sales volume, pricing, and cost management. Key components include fixed and variable costs, the Break Even Chart for visual representation, and concepts like Margin of Safety and Profit Volume Ratio to assess business performance.

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8 views13 pages

Unit 5 Break Even Analysis

Break Even Analysis examines the relationship between cost, volume of production, and profit, focusing on the point where neither profit nor loss occurs, known as the Break Even Point. It can be conducted using algebraic or graphical methods, with the latter being more common, and is essential for determining necessary sales volume, pricing, and cost management. Key components include fixed and variable costs, the Break Even Chart for visual representation, and concepts like Margin of Safety and Profit Volume Ratio to assess business performance.

Uploaded by

bakareomkar01
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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BREAK EVEN ANALYSIS

Break Even Analysis is the study of cost-volume of


production profit (CVP) relationship.
Profit mainly depends upon three factors-
1. Cost of production 2. Amount of input 3. Sales revenue
Cost of production = Variable cost + Fixed cost.
Fixed cost are assumed to be constant at all levels of output.
e.g. Expenditure on permanent labors and overheads
(Administrative cost).
Variable cost increases with the increase of output of
production i.e. (material cost , inventory cost etc.)
One of the technique to study the total cost , total revenue and
output relationship is known as Break Even Analysis.
Hence, Break Even Analysis is the study of cost, volume of
production and profit relationship.
It is an analysis to study the point where neither profit nor loss
is occurred. This point is known as Break Even Point.

The break Even Analysis can be done in two ways:


• Algebraic method
• Graphical method
But, usually a Break Even Analysis is done graphically.
Importance of Break Even Analysis

•It helps in solving the following types of problems:

•What volume of sales will be necessary to cover a

reasonable return on capital Investment?

•Computing costs and revenues for all possible volumes of

output.

•To find the price of an article to give the desired profit.

•To determine the variable cost per unit.


ASSUMPTIONS IN BREAK EVEN ANALYSIS
•The total cost of production is comprised of fixed cost
and variable cost.
•Fixed cost remains constant i.e. it is independent of the
quantity produced, it includes salaries, rent of buildings,
depreciation of plants and equipment's etc.
•Variable cost is directly proportional to the volume of
production.
•Selling price doesn’t change with the volume of change.
•Total sales income is P X Q where, P is selling price and
Q is the quantity produced.
Break Even Chart

It was invented by Walter Rautenstrauch, an


Industrial Engineer and professor of Columbia University in
1930.

It is a graphical representation of relationship


between various costs and sales revenue at a given time.
It determines the Break Even Point.
Functions of Break Even Chart
•It is an aid to management and it depicts a clearer view of
the status of the business.
•It is a graphic representation of the economic position of the
business.
•It shows the profits and losses at various output level.
•It shows the relationship between Marginal Cost and fixed
Cost.
•It indicates No profit, No loss situation and margin of safety.
•It can help by making specific plans to effect profit through
the control of expenses.
•Volume of production , number of units produced is plotted
along the x-axis (Horizontal axis).
•The fixed cost is represented by straight line parallel to the
horizontal axis.
•The cost and sales income (sales revenue) are plotted along y-
axis(vertical axis).
•The sales income line passes through the origin.
•The point of intersection of sales income line and the total cost
line represent the break-even point (B.E.P.).
•Shaded area between the total cost line and sales income/
revenue line on the left hand side of B.E.P. indicates loss and
the right hand side of the BEP indicates profit.
Margin of Safety: It is the distance between the BEP and
the output being produced at a particle variable cost line.
If this distance is large, the profit will be large even there
is a drop in production and vice-versa.
𝑆𝑎𝑙𝑒𝑠−𝑆𝑎𝑙𝑒𝑠 𝑎𝑡 𝐵𝐸𝑃
Margin of Safety = ---------------------------------- x 100
𝑆𝑎𝑙𝑒𝑠
𝑃𝑟𝑜𝑓𝑖𝑡 𝑋 𝑠𝑎𝑙𝑒𝑠
= -----------------------------------
𝑆𝑎𝑙𝑒𝑠−𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡
Angle of Incidence( θ): This is the angle at which sales revenue

cuts the total cost line.

A larger θ indicates more profit at a higher rate.

A larger angle of Incidence at a high margin of safety marks the

extremely favorable business position.


Profit Volume Ratio(P/V):
It measure the profitability in relation to sales. It determines the
B.E.P., can be increased by increasing the sales price and
reducing the variable cost.
Contribution Increase in profit
P/V/ Ratio = ------------------ x 100 = --------------------------- x 100
Sales Increase in sales
Total sales – Total variable cost S-V
=------------------------------------------x 100 = -------x 100
Total sales S
Fixed cost + Profit
= --------------------------- x 100
Sales
Price per unit – Cost per unit
= --------------------------------------- x 100
Price per unit

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