I NT RO DUCT I O N T O B RE AK - E VE N A NAL YS I S (or Cost-Volume-Profit Analysis) Introduction: Break-even analysis is also termed as cost-volume-profit analysis.

The term break-evenanalysis is used in two senses--- narrow sense and broad sense. In its broad sense, breakeven analysis refers to the study of relationship between costs, volume and profits at different levels of sales or production. In its narrow sense, it refers to a technique of determining that level of operations, where total revenues equal total expenses, i.e., the point of no profit, no loss. Importance/ Advantages of Breakeven Analysis: It is useful for studying the relationship of cost volume and profit. It is a tool for exercising cost control because it shows the relative importance of the fixed cost and the variable cost. It helps in formulating price policy. It helps the management in taking decisions regarding manufacturing the product in-house or purchasing the products from outside the organization. It is a tool to analyze Break-even point at different levels of activity or sales volume. It assists the management in taking certain decisions regarding changes in various factors in the period of recession and boom. Limitations: Fixed cost may not always remain fixed with a change in volume. Sometimes, costs can not be segregated into fixed and variable components. Selling price may not remain constant. Variable cost per unit remain constant. There may be a difference in the production and sales. Assumptions of Break-Even Analysis: Selling price per unit remains constant at all levels of output.

 Fixed costs remain constant irrespective of volume of output. There will be no change in the general price level. All elements of cost are divided into categories. Such as, fixed and variable. BREAK-EVEN POINT: The point in terms of rupees or units at which the total cost equal to total revenue so that there is neither profit nor loss. This point is also known as critical point or Equilibrium point or Balancing point. Break-even point can be stated in the form of an equation: Sales revenue at break-even point = Fixed costs + Variable costs. i) Break-Even Point is where total costs equal Sales. ii) The break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain, The break-even point is one of the simplest yet least used analytical tools in management. It helps to provide a dynamic view of the relationships between sales, costs and profits. Computation of Break-even Point: a. Break-even point in units: Break-even point = Fixed cost Selling price per unit Variable cost per unit

Or =

Fixed cost Contribution per unit Break even sales Selling price per unit

Or =

b. Break-even point in terms of budget-total or break-even point in terms of sale: (or Break-even sales) Break-even sales: = Fixed Cost Sales Variable Cost Sale s Sales Sales

Or = Fixed Cost Contribution

Or = B.E.P in units x Selling price per unit

Or = Fixed Expenses P/V ratio c. Break-even point as a percentage of estimated capacity: B.E.P (as % age of capacity) = Fixed Cost Total Contribution

Calculation of sales for a desired or expected Profit: (where expected or desired profit given in the question): (or sales required to earn a profit of Rs.) Sales = Fixed Expenses + Desired Profit P/V ratio

Or Sales = Fixed Expenses + Desired Profit (Selling price per unit Variable cost per unit) = Fixed Expenses + Desired Profit Contribution per unit CONTRIBUTION: Contribution is the difference between sales and variable cost or marginal cost of sales. It may also be defined as the excess of selling price over variable cost per unit. Contribution = Sales Variable cost or Contribution (per unit) = Selling price Variable cost per unit. Or Contribution = Fixed costs + Profit ( - Loss) Or Contribution = Sales x P/V ratio Advantages of contribution: a) It helps the management in the fixation of selling price. b) It assists in determining the break-even point. c) It helps management in the selection of a suitable product mix for profit maximization. d) It helps the management in profit planning. e) It helps the management in the evaluation of performance. Or Sales

P/V RATIO (OR PROFIT / VOLUME RATIO or C/S RATIO): The P/V ratio, which establishes the relationship between contribution and sales. It is vital importance for studying the profitability of operations of a business. Higher the P/V ratio, more will be the profit and lower the P/V ratio, lesser will be the profit. Thus, every management aims, at increasing P/V ratio. The Profit/ volume ratio, which is also called the contribution ratio or marginal ratio, expressed the relation of contribution to sales and can be expressed as under: P/V ratio = Contribution Sales x 100 or P/V ratio = Contribution per unit Selling price per unit

Or P/V ratio = Sales Variable cost Sales or P/V ratio = Selling price per unit- Variable cost per unit Selling price per unit Or P/V ratio = Fixed cost + Profit Sales P/V ratio = Change in profit Change in sales Change in contribution Change in sales

Or

Or

P/V ratio =

The concept of P/V ratio helps in determining the following:

Breakeven point Profit at any volume of sales Sales volume required to earn a desired quantum of profit Profitability of products Processes or departments It reveals the effect on profit of changes in the volume.

PROFIT: Profit = Contribution Fixed cost Or Profit = (sales-variable cost) Fixed cost

MARGIN OF SAFETY: The excess of actual sales over the break-even sales is known as the margin of safety. It is the difference between actual sales minus the sales at break-even point. The size of the margin of safety is an important indicator of the strength of a business. The large margin of safety indicates that the business is sound and small margin of safety indicates that position of the business is comparatively weak. Margin of safety (in monetary terms) = (Total sales or Actual sales - Break-even sales.) Or Margin of safety = Profit P/V ratio Margin of safety ratio (in % term) = Margin of safety x 100 Sales Or Profit = Margin of safety x P/V ratio ANGLE OF INCIDENCE: The angle of incidence is the angle between the sales line

and the total cost line formed at the break-even point, where the sales line and the total cost line interest each other. The angle of incidence indicates the profit earning capacity of a business. If the angle is large, it indicates the profits are being made at high rate. If the angle of incidence is small, it indicates that profits are being made under less favorable condition.

THE BREAK-EVEN CHART: Breakeven chart is a device which shows the relationship between sales volume, marginal costs and fixed costs, and profit or loss at different levels of activity. Such a chart also shows the effect of change of one factor on other factors and exhibits the rate of profit and margin of safety at different levels. A breakeven chart contains, total sales line, total cost line and the point of intersection called breakeven point. It is popularly called breakeven chart because it shows clearly breakeven point (a point where there is no profit or no loss). In the following diagram , the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of

intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.

Advantages or uses of Break-even charts: 1. Information provided by the break-even chart is in a simple for and is clearly understandable even to a layman. 2. The break-even charts help in knowing and analyzing the profitability of different products under various circumstances. 3. A break-even chart is very useful for forecasting, planning and growth. 4. The break-even chart is a managerial tool for control of costs as it shows the relative importance of fixed cost in the total cost of a product. Limitations of Break-even chart: 1. A break-even chart does not suggest any action or remedies to the management as a tool of management decisions. 2. Break-even charts present only cost-volume-profit relationships but ignore other important considerations such as the amount of capital investment, marketing problems and government policies, etc. 3. Break-even chart presents only a static view of the problem under consideration. LINEAR BREAK-EVEN ANALYSIS: In linear break-even analysis, revenue and variable costs are directly proportional to output. There are three primary conditions for linear break-even analysis:(i) Income is only from operations under considerations.

(ii) Fixed costs, per unit variable costs and per-unit sales price remain constant over time and over output.