BREAK EVEN ANALYSIS

CONTENTS

 definition

 Purpose

 Construction/Computation

 Margin of safety

 Types of costs

 Break even analysis

 Limitations

 Available calculators for

calculating BEP

conclusion
DEFINITION
“Break even point (Bep) is the point
at which cost or expenses and
revenue are equal”

 There is no net loss or gain

 All cost that need to by paid by the firm are paid

but the profit remains “zero”
Break Even Point (IN UNIT)= Fixed
Cost /S. Price- Variable Unit Cost

Break Even Point (in Rs)=Fixed

Cost/ S. Price-Variable unit
Cost*Units
 Example:
XYZ co. ltd
1000 tables ( break even)
More than 1000 tables( profit )
Less than 1000 tables(loss )

Alternate option

Try to reduce the fixed costs (by renegotiating rent for example,
or keeping better control of telephone bills or other costs)

Try to reduce variable costs (the price it pays for the tables by
finding a new supplier)

Increase the selling price of their tables

 purpose
The purpose of break-even analysis is to provide a
rough indicator of the earnings impact of a marketing
activity.

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

The break-even point is a special case of Target Income

Sales where Target Income is 0 (breaking even).

This is very important for financial analysis.

Computation /construction of BEP
LINEAR COST-VOLUME-PROFIT ANALYSIS MODEL

Where, marginal cost and marginal revenue are constant BEP can be directly
computed in terms of total revenue(TR) and total cost (TC)

TFC is Total Fixed Cost

P is Unit Sale Price

V
. is Unit Variable Cost

X is BEP (in terms of unit sales)

Alternative method
Where,
Contribution equals Fixed Cost

Total Contribution=Total Fixed Costs

Unit Contribution X Number Of Units=Total Fixed

Costs

Number Of Units= Total Fixed Costs

Unit Contribution
 MARGIN OF SAFETY

Margin of safety represents the strength of the

business

It enables a business to know what is the exact

amount it has gained or lost and whether they are
over or below the break-even point

FORMULA

Margin of safety = (current output - breakeven

output)

Margin of safety% = (current output - breakeven

output)/current output × 100
 Break-Even Analysis
TR (p = £3) TR (p = £2)
TC
Costs/Revenue
VC AAssume
higher price
would lower
current sales
the
at break
Q2
even point
and the
margin of
safety would
Margin of Safety widen
FC

Q3 Q1 Q2 Output/Sales
Important things to be considered before
conducting break- even analysis

 FIXED COST

VARIABLE COST

SETTING PRICE

 PHYCHOLOGY OF PRICING

PRICING METHODS
 TheAs Break-even
output is point
Costs/Revenue Total
The
occurs revenue
Thewhere
total total
lower is
costs
the
TR TR TC generated,
Initially a by
determined
therefore
the
firm the
VC price,
revenue
firm the
equals
will
willcharged
less
total
incur
incur fixed
price
costs – the
(assuming firm, and
in
steep the
variable
costs, total
costs
thesesolddo– –
thisthe quantity
example
accurate
these vary would
revenue
not depend
again
to this
haveforecasts!)
sell
curve.
Q1
onbe
willto
directly
output or
determined with is
the
sales.
by the
generate
sum
amount sufficient
of produced
FC+VC
expected
revenue to cover forecastits
sales
costs. initially.

FC

Q1 Output/Sales
 Break-Even Analysis If the firm
chose to set
price higher
Costs/Revenue than £2 (say
TR (p = £3) TR (p = £2) TC
VC £3) the TR
curve would
be steeper –
they would
not have to
sell as many
units to
break even

FC

Q2 Q1 Output/Sales
 Break-Even Analysis
TR (p = £1)
Costs/Revenue If the firm
TR (p = £2)
TC chose to set
VC
prices lower
(say £1) it
would need
to sell more
units before
covering its
costs

FC

Q1 Q3 Output/Sales
 example,
suppose that your fixed costs for
producing 100,000 product were 30,000 rs a
year.
Your variable costs are 2.20 rs materials,
4.00 rs labour, and 0.80 rs overhead, for a
total of 7.00 rs per unit.
If you choose a selling price of 12.00 rs for
each product, then:
30,000 divided by (12.00 - 7.00) equals
6000 units.
This is the number of products that have
to be sold at a selling price of 12.00 rs
before your business will start to make a
profit.
LIMITATIONS
•Break-even analysis is only a supply-side (i.e., costs only)
analysis, as it tells you nothing about what sales are actually likely
to be for the product at these various prices.

•It assumes that fixed costs (FC) are constant. Although this is
true in the short run, an increase in the scale of production is likely
to cause fixed costs to rise.

•It assumes average variable costs are constant per unit of output,
at least in the range of likely quantities of sales. (i.e., linearity).
It assumes that the quantity of goods produced is equal to the
quantity of goods sold (i.e., there is no change in the quantity of
goods held in inventory at the beginning of the period and the
quantity of goods held in inventory at the end of the period).

In multi-product companies, it assumes that the relative proportions

of each product sold and produced are constant (i.e., the sales mix is
constant).
CALCULATORS

Case Western Reserve University offers a breakeven

analysis calculator that includes a review of relevant
microeconomic terms.

 financial calculator allows you to chart your costs and

profits appear in a graph.

Inc.com offers a breakeven analysis calculator that requires

a user to enter in total annual overhead and annual year-to-
date sales and cost of sales, and lets the user delineate the
period for the YTD calculations in terms of weeks
CONCLUSION

“Breakeven analysis is not a predictor of

demand, so if you go into market with
the wrong product or the wrong price, it
may be tough to ever hit the breakeven
point”