Breaking Even Analysis
The narrower interpretation of the term break even analysis refers to a system of determination
of the level of activity where total cost equals total selling price.
The broader interpretation refers to that system of analysis which determines the probable profit
at any level activity.
The relationship among cost of production, volume of production, the profit and sales value is
established by breakeven - analysis, hence this analysis is also designated as “Cost Volume
Profit analysis.”
Such an analysis is useful to Management Accountant in the following respect:
1. It helps him in forecasting the profits fairly accurately.
2. It is helpful in setting up flexible budgets: since on the basis of this relationship,
he can ascertain the cost, sales and profit at different levels of activity.
3. It also assists his performance evaluation for purposes of Management Control.
4. It helps in formulating price policy by projecting the effect which different price
structures will have on costs and prices.
5. It helps in determining the amount of overhead, cost to charge at various level of
operations, since overhead rates are generally predetermined on the basis of the selected
volume of production.
Thus, cost profit volume analysis is an important media through which management can have an
insight into effects on profits on account of variations in cost( both fixed and variable ) and sales
( both volume and value) and take appropriate decisions.
Breaking Even Analysis
The point which breaks the total cost and the selling price evenly to show the level of
output or sales at which there shall be neither profit nor loss, is regarded as breakeven
point At this point the income of the business is exactly equals its expenditure. If
production is enhanced beyond this level profit shall be earned
by the business.
It will be proper to understand different concepts regarding marginal cost and break-even
point before proceeding further:
1. Marginal Cost = Total Variable Cost
i. Or =Total Cost – Fixed Cost
ii. Or = Direct material +D Labour+ D Expense
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(Variable) + Variable Overheads
2.
3.
4.
5.
Contribution = Selling Price – Variable Cost
Profit = Contribution – Fixed Cost
Fixed Cost = Contribution – Profit
Contribution = Fixed Cost + Profits
A. Break Even Point of total output:BEP (Total Output) = fixed Cost
Contribution /Per Unit
B. BEP for total Sales
BEP (Total Sales)
= Total output x Selling price / Unit
= Fixed Costs x Selling Price /Unit
Contribution /Per Unit
= Fixed Cost x Total Sales
Total Contribution
= Fixed Cost
Profit/volume Ratio
Profit/Volume Ration
= Contribution/Per Unit x 100
Selling Price/ Per Unit
= Total Contribution x 100
Total Sales
At Break Even Point the desire profit is zero (0). In case the volume of output or sales is to be
computed for a desired profit. The amount of “desired profit” should be added to fixed cost as
indicated below:
1. Unit for a desired profit = Fixed Cost + Desired Profit
Contribution / Per Unit
2. Sales for a desired profit = Fixed Cost + Desired Profit
Profit Volume Ratio
Problem 1
The fixed cost of a company is $30,000 p.a. prime cost is $6 per unit. Variable
Overheads are $4 per unit. Selling price is $20 per unit. Present sales are 20,000 units a
year. Calculate the break-even point in sales and units.
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Problem 2
1. Calculate the break-even point from the following particulars:
Budgeted output
80,000 units
Fixed Expenses
$45,000.
Variable Cot Unit
$15.00
Selling Cost per unit
$25.00
If the selling price is reduce to $20 per unit, what will be the new break-even point?
Problem 3
A factory manufacturing sewing machines has the capacity to produce 500 machines per annum.
The marginal (variable) cost of each machine is $200, and each machine is sold for $250. Fixed
costs are $12,000 per annum. Calculate the break even points for output and sales and show what
profit will result if out output is 90% of Capacity.
Marginal Safety
Total sales unit minus the sales at breakeven point is known as the “margin of safety.
Thus formula:
M.S. = T.S. – B.E.S.
Margin of safety = Total Sales – Sales at Break – even point.
Margin of Safety can also be computed according to the following formula:
Margin of Safety = Net profit
P/V Ratio
Margin of Safety can also be expressed as a percentage of sales
= Margin of Safety
Total Sales
If the margin of safety is large, it is sign of soundness of the business since even with a
substantial reduction of sales, profit shall be earned by the business. If the margin is small,
reduction in sales even to a small extent may affect the profit position very adversely and larger
reduction of sales value may even result in losses. Thus, margin of safety serves as an indicator
to the strength of the business.
In order to rectify the unsatisfactory margin of safety, the management can take the following
steps:
(i ) Selling prices may be increased, but it should not affect the demand adversely
otherwise the sales revenue net shall stand reduced.
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(ii) Fixed or the variable cost may be reduced
(iii) Production may be enhanced, but it should be at a lower cost.
(iv) Unprofitable products may be substituted by profitable ones.
Total sales unit minus the sales at breakeven point is known as the “margin of safety. Thus
formula:
M.S. = T.S. – B.E.S.
Margin of safety = Total Sales – Sales at Break – even point.
Margin of Safety can also be computed according to the following formula:
Margin of Safety = Net profit
P/V Ratio
Margin of Safety can also be expressed as a percentage of sales
= Margin of Safety
Total Sales
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