BREAK – EVEN ANALYSIS

Cost & Cost Classification

Fixed & Variable Costs
Marginal Cost, Contribution
Break-even Point Analysis
 Cost
• Cost is a resource sacrificed or foregone
• Compensation expressed in monetary terms
paid to a supplier of any service or goods
• Costs are no longer looked at on a
piecemeal basis but rather holistically
 Classification

• By Cost Elements
• By Directness
• Costs & their revenue linkages
– Fixed vs. Variable
Elements of Cost
• Material
• Labour
• Expenses
 Classification by Directness
• Direct Cost
Costs which can be economically traced to a
Cost Object
• Indirect Costs
Costs which cannot be economically traced
to a Cost Object
 Combination of elements &
directness
• Direct Material
• Direct Labour
• Direct Expenses
• Overheads
– Indirect Material
– Indirect Labour
– Indirect Expenses
 Cost Elements & final product
Product 1
Material
Product 2
Labour
Product 3
Expenses
Cost Center 1 Product 4
Overheads
Cost Center 2 Product 5

Cost Center 3 Product 6

Cost Center 4 Product 7

 Behaviour of costs
• Some costs are linked with time
– They are called as Fixed Costs
• Some costs are linked with volume of work or
activity
– They are called as Variable Costs
 Variable Costs
• Change in direct proportion to changes in activity
• Examples,
– Cost of Materials
– Fuel
• Cost per unit of activity remains the same whereas the
aggregate cost changes with activity / volumes
Aggregate
Costs Variable
Costs

Per Unit
Variable Costs
Activity/ Volume
 Management of Variable Costs
Variable costs directly impact contribution
Small changes could result in high impact

Examples :
• Negotiating for a lower price
• Substitution of raw materials or change in mix without
change in quality
• Alternate sourcing of raw materials
• Technological breakthrough
• Improved efficiency in energy utilization
• Improvement in input-output ratio
• Realizing higher value for by-products or wastages
 Marginal Cost
• The cost of producing one extra unit

• Usually, marginal cost = variable cost

• When capacity is constrained, marginal cost

could be more than variable cost due to the
cost of capacity creation
 Fixed Costs
• Remains unchanged for a given time period, may
step up beyond a certain activity level
• Costs of capacity creation
• Aggregate is first known, per unit is derived based
on the activity / volume
Costs Aggregate
Fixed Costs

Per Unit
Fixed Costs

Activity/ Volume
 Management of Fixed Costs
• Linked to capacity build up
– Land and building
– Plant and Equipment
– Human Resources

• Capacity utilization is the key

• The other is tighter control on time
Contribution Income Statement
Sales and Revenue
(-) Variable Costs
Contribution (1)
(-) Fixed Cost
PBIT or Operating Income (2)
(-) Interest
PBT (3)
(-) Tax
PAT (4)
Contribution Margin %

Contribution
___________________ X 100
Total Revenue
 Break – Even Point (BEP)
• A level of volume or activity at which profit is 0
• At BEP, the organization has, on the positive side,
the critical mass to move into a profit zone and on
the negative side, the risk of slipping into losses
• Lower the break-even point the better
• Each organization has to monitor how far it is
from it : Check its safety zone
 Break Even Chart

2500
Costs and Revenue ( Rs. )

2000
Variable Costs
1500
BEP Fixed Costs
FC + VC
1000 Revenues

500

0
0 250 500 750 1000
Output
 Calculation of Break Even Point
x = number of units s = selling price / unit
v = variable cost / unit P = profit
F = Fixed cost
P = sx – vx – F At Breakeven P = 0
0 = sx – vx – F x (s-v) = F

Breakeven volume x = F / (s-v)

s – v = c --- contribution / unit
 Case 2
• A Company has fixed costs of Rs. 1,00,000/-. It
manufactures boxes, which have a material cost of
Rs. 80/- per box and each box requires Rs. 20/- as
other variable costs.
• The selling price is Rs. 150/- per box. What are
the break-even volume and break-even sales?
• If the company wants a profit of Rs. 30,000/- how
many boxes should be sold?
 Calculation of Break Even Point
Case 2
s = 150
v = 100
F = 1,00,000
Breakeven volume x = F / (s-v)
= 100000/50 = 2000 units

Target profit can be taken as fixed cost – rent to be

paid to owner
So for profit of 30000
x = 130000/50 = 2600 units
 Case 3
• A Company has a profit of Rs. 1,00,000/- on sales
of Rs. 10,00,000/- and when sales are Rs.
15,00,000/- the profit is Rs. 2,00,000/-.
• What is the break-even sales revenue?
• What is the fixed cost?
• If the company targets a profit of Rs. 3,00,000/-
what should the sales be?
 Calculation of Break Even
Case 3
Sales Profit Total cost
10 1 9
15 2 13
Incremental
5 (sales) 1 4 – variable cost only
So v / s = 4 / 5 = 0.8
Sales Profit Total cost = variable + fixed
10 1 9= 8+1
15 2 13 = 12 + 1 - Fixed cost = 1

Formula Break even Revenue = xs = Fs / (s-v) = F / ( 1 – v/s) =

= 1 / .2 = 5 lacs
For profit of 3 = 4 / .2 = 20 lacs
 Calculation of Break Even Point
• Break-even Number of Units (in a single product
co.)
Fixed Costs
______________________
Contribution Margin Per Unit
• Break-even Revenue Level
Fixed Costs
______________________
Contribution Margin %
 Margin of Safety
• Margin of Safety in units =
Current level of activity in units – Break Even
Point in Units
• Margin of Safety expressed in Revenue Level
(Rs.)
Current Level of revenue - Break even revenue
level
PROCESS OF PLANNING
AND BUDGETING
 PLANNING
• To plan is to produce a scheme for future action; to bring
about specified results, at specified costs, in a specified
period of time.
• Planning takes place at each managerial and supervisory
level
• Planning is deciding in advance what to do, how to do,
when to do and who is to do it. It bridges the gap from
where we are to where we want to go.
• It is deciding the best alternatives among others to
perform different managerial operations in order to
achieve the pre-determined goals.
BASIC PLANNING PROCESS

Situational Analysis

Alternative Goals & Plans

Goals & Plans Evaluation

Goals & Plan Selection

Implementation

Monitor and Control

 BUDGETING
• “Budget is a financial and/or quantitative statement, prepared prior
to a defined period of time, of the policy to be pursued during that
period for the purpose of attaining a given objective.”

• The term, “Budget” is derived from the French word “Budgette”,

which means small leather bag.

• Budget - plan for where you are going to spend your money and
where the money is going to come from.

• Financial forecasting is a tool for aggregate planning over a fairly

long period of time, the budget is an instrument for detailed
operational planning and control over a short period of time, usually
one year.
 Characteristics of Budgeting

• The budget serves as a standard for comparison. It is a baseline

from which to measure the difference between the actual and
planned use of resources
• Budgeting procedures must associate resource use with the
achievement of organizational goals or the planning/control
process becomes useless
• The budget is simply the project plan in another form

In order to develop a budget, we must:

Forecast what resources the project will require
Determine the required quantity of each
Decide when they will be needed
Understand how much they will cost - including the effects of
potential price inflation
 The Budget Period:
• The yearly budget may be divided into quarterly
budgets or monthly budgets.
• Often based upon historical data accumulated through an
accounting system
• With the advent of project organizations, it became necessary
to organize the budget in ways that conformed more closely
to the actual pattern of fiscal responsibility. Common system
for all projects allow for the use of historical data for future
projects
Operating Cash Projected Sources and
Budget Budget Balance sheet Uses of funds
Statement

Sales
Budget
Capital Investment and
Production budget Expenditure Financing
Budget Budget
Materials and
Purchases Budget

Labor cost
Budget
Manufacturing
Overhead Budget

Non-
Manufacturing
Overhead budget
 Master Budget
• Master budget has detailed planning of the entire
business in one budget. Most of the business
organizations involve themselves in preparation of the
master budget.
• Master budget shows how each department budget
promotes the business as a whole.
• It has four major components:
– The operating budget
– The capital expenditure budget
– The cash budget
– The projected financial position
 Steps in preparing a Master Budget
• Prepare a Sales Forecast:The sales forecast is the starting point in the
preparation of a master budget. This forecast is based on past experience,
estimates of general business and economic conditions, and expected levels
of competition. A forecast of expected levels of sales is a pre-requisite to
scheduling production and to budgeting revenue and variable costs.
• Prepare budgets for production, manufacturing costs and operating
Expense
• Prepare a budgeted income statement: The budgeted income statement is
based on the sales forecast, the manufacturing costs comprising the cost of
goods sold, and the budgeted operating expenses
• Prepare a cash budget: The cash budget is a forecast of the cash receipts
and cash payments for the budget period.
• Prepare a budgeted balance sheet:- A projected balance sheet cannot be
prepared until the effects of cash transactions on various asset, liability and
owners equity accounts have been determined. In addition the balance sheet
is affected by budgeted capital expenditure and budgeted income