Break Even Point
The concept of ‘Break Even Point’ is extremely important for decision making in various areas. This
concept is based on the behavior of costs, i.e. fixed cost and variable costs. As discussed earlier, fixed
costs are those costs that remain constant irrespective of the changes in the volume of production. On
the other hand, variable costs are the costs that vary with the level of production. While fixed cost per
unit is always variable, variable cost per units is always fixed. In addition to these two types of costs,
there are semi variable costs that are partially fixed and partially variable. Semi variable costs thus have
the features of both types of costs. They remain fixed up to a certain level of production and after
crossing that level, they become variable.
The Break Even Point is a level of production where the total costs are equal to the total revenue, i.e.
sales. Thus at the break even level, there is neither profit nor loss. Production level below the breakeven-point will result into loss while production above break-even point will result in profits.
Break even level can also be worked out with the help of the following formulae.
Break even point [in units] =
Break even point [in Tk.] =
[ / ]
Break even point can also be shown on the graph paper as follows:
Explanation: On horizontal axis, production and sales volume is shown while on the vertical axis, sales
and costs in amount are shown.
Assumptions of Break Even Point: The concept of break even point is based on the following
assumptions.
1. Production and sales are the same, which means that as much as is produced is sold out in the
market. Thus there is no inventory remaining at the end.
2. Fixed cost remains same irrespective of the production volume.
3. Variable cost varies with the production. It changes in the same proportion that of the
production. Hence it has a linear relationship with the production. In other words, variable cost per
unit remains the same.
4. Selling price per unit remains same irrespective of the quantity sold.
Margin of Safety: Margin of Safety is the difference between the actual sales and the break even
sales. As we have discussed, at the break even point there is neither any profit nor loss. Hence any firm
will always be interested in being as much above the break even level as possible. Margin of safety
explains precisely this thing and the higher the safety margin the better it is. Margin of safety is
computed as follows.
Margin of Safety = Actual Sales – Break Even Sales.
Limitations of Break even Point: Break Even point is extremely useful in decision- making regarding
the production level. It indicates the level of production where there is neither any profit nor loss.
However this is based on the assumption that the variable cost per unit, sales price per unit and the
fixed cost remains the same. If there is any change in these variables, the break even point will give
misleading results.
Problems and Solutions:
1. A Company budgets for a production of 150000 units. The variable cost per unit is Tk.14 and fixed
cost per unit is Tk.2 per unit. The company fixes the selling price to fetch a profit of 15% on cost.
Required:
A. What is the break- even point?
B] What is the profit/volume ratio?
C] If the selling price is reduced by 5%, how does the revised selling price affects the Break Even Point
and the Profit/Volume Ratio?
D] If profit increase of 10% is desired more than the budget, what should be the sales at the reduced
price?
Solution:
A] Break Even Point
=
=
=
.
.
. ,
.
,
,
,
–
. .
= 68,182 units.
.
.
Note: Contribution per unit is computed as shown below.
Selling Price per unit = Total Cost + 15% Profit on cost
= [Tk.14 variable cost + Tk.2 fixed cost] + [15% of Tk.16]
= Tk. 16 + Tk.2.40
= Tk.18.40
Contribution = Selling Price – Variable Cost
= Tk.18.40 – Tk.14
= Tk.4.40
B] Profit/Volume Ratio:
X 100
. .
=
.
X 100
.
= 23.91%
C] Reduction in selling price by 5%:
Reduced selling price = Tk.18.40 – (5% of Tk.18.40)
= Tk.17.48
Revised contribution = Tk.17.48 – Tk.14.00 = Tk.3.48
Break Even Point
=
=
. ,
. .
,
= 86,207 units
D] Desired profit per unit
= Tk.2.40 + (10% of Tk.2.40)
= Tk.2.64 per unit
= Tk.2.64 X 1,50,000 units
= Tk.3,96,000
Total Desired Profits
Desired Contribution
= Total Desired Profits + Total Fixed Costs
= Tk.3,96,000 + Tk.3,00,000
= Tk.6,96,000
Quantity to be sold =
=
. ,
,
. .
= 2,00,000 units
Sales Value = 2,00,000 units X Tk.17.48
= Tk.34,96,000.
2. Menlo Company distributes a single product. The company’s sales and expenses for last Month
are following:
Sales
Variable expenses
Contribution margin
Fixed expenses
Net operating income
Total Tk.
450,000
180,000
270,000
216,000
54,000
Per Unit Tk.
30
12
18
Required:
i. What is the monthly break-even point in units sold and in sales taka?
ii. Without resorting to computations, what is the total contribution margin at the breakeven point?
iii. How many units would have to be sold each month to earn a target profit of tk. 90,000?
iv. Refer to the original data. Compute the company’s margin of safety in both taka and
percentage terms.
3. Voltar Company manufactures and sells a specialized cordless telephone for high
electromagnetic radiation environments. The company’s contribution format income statement
for the most recent year is given below:
Total
Per Unit
Percent of Sales
Sales (20,000 units) .....................Tk.1,200,000
Tk.60
100%
Variable expenses .......................... 900,000
45
?%
Contribution margin ........................ 300,000
Tk. 15
?%
Fixed expenses .............................. 240,000
Net operating income .....................Tk. 60,000
Management is anxious to increase the company’s profit and has asked for an analysis of a
number of items.
Required:
i. Compute the company’s CM ratio and variable expense ratio.
ii. Compute the company’s break-even point in both units and sales Tk. Use the equation method.
iii. Assume that sales increase by Tk.400,000 next year. If cost behavior patterns remain
unchanged, by how much will the company’s net operating income increase? Use the CM ratio to
compute your answer.