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Chapter 6 Breakeven Analysis
Chapter 6 Breakeven Analysis
Lesson 6
Breakeven or Cost – Volume – Profit Analysis
Introduction
Breakeven analysis is also known as cost volume profit analysis. It is the study of the relationship
between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of
activity. Breakeven analysis can be used to determine a company’s breakeven point (BEP).
Breakeven point is a level of activity at which the total revenue is equal to the total costs. At this
level the company makes no profit or no loss
Calculating the breakeven point
Contribution is so called because it literally does contribute towards fixed costs and profit. As
sales revenues grow from zero, the contribution also grows until it just covers the fixed costs. This
is the breakeven point where neither profits nor losses are made. It follows that to breakeven, the
amount of contribution must exactly match the amount of fixed costs. If we know how much
contribution is earned from each unit sold, then we can calculate the number of units required to
break even as follows:
Breakeven point in units =
Exercise 01
Suppose that an organization manufactures a single product, incurring variable costs of Rs.30
per unit and fixed costs of Rs.20, 000 per month. If the product sells for Rs.50 per unit, calculate
the breakeven point.
The margin of safety is the difference between the expected level of sales and the breakeven point.
The larger the margin of safety, the more likely it is that a profit will be made, i.e. if sales start to
fall there is more leeway before the organization begins to incur losses.
Exercise 02
If forecast sales are 1,700 units per month, calculate the margin of safety & monthly profit of
Exercise 01.
Exercise 03
Exercise 04
A company manufactures and sells a single product that has the following cost and selling price
structure:
Rs. Rs.
Selling price 120
Direct material 22
Direct labor 36
Variable overhead 14
Fixed overhead 12 (84)
Profit per unit 36
The fixed-overhead absorption rate is based on the normal capacity of 2,000 units per month.
Assume that the same amount is spent each month on fixed overheads. Budgeted sales for next
month are 2,200 units.
You are required to calculate:
a. The breakeven point, in sales units per month;
A basic breakeven chart records costs and revenues on the vertical axis and the level of activity
on the horizontal axis. Lines are drawn on the chart to represent costs and sales revenue. The
breakeven point can be read off where the sales revenue line cuts the total cost line.
Exercise 05
One of the problems with the conventional or basic breakeven chart is that it is not possible to
read contribution directly from the chart. A contribution breakeven chart is based on the same
principles but it shows the variable cost line instead of the fixed cost line. The same lines for total
cost and sales revenue are shown so the breakeven point and profit can be read off in the same
way as with a conventional chart. However, it is also possible to read the contribution for any
level of activity.
Exercise 06
Draw the contribution breakeven chart by using the data of the Exercise 05.
Exercise 07
Draw the profit–volume chart by using the data of the Exercise 05.
The main advantage of the profit–volume chart is that it is capable of depicting clearly the effect
on pro t and breakeven point of any changes in the variables. An example will show how this can
be done.
Exercise 08
A company manufactures a single product which incurs fixed costs of Rs.30,000 per annum.
Annual sales are budgeted to be 70,000 units at a sales price of Rs.30 per unit. Variable costs are
Rs.28.50 per unit.
a) Draw a profit–volume chart, and use it to determine the breakeven point.
The company is now considering improving the quality of the product and increasing the
selling price to Rs.35 per unit. Sales volume will be unaffected, but fixed costs will increase to
Rs.45, 000 per annum and variable costs to Rs.33 per unit.
b) Draw, on the same graph as for part (a), a second profit–volume chart and comment on the
results.
Short-term decision-making
An important point that you should appreciate for all of the decision-making techniques that you
learn about in this chapter is that they are usually most relevant to short-term, one-off decisions.
Furthermore, as you will see with the example of the minimum-price quotation, the analysis
provides only a starting point for management decisions. The financial figures are only part of
the information needed for a fully informed decision. It is also important to consider the non-
financial factors which might be relevant to the decision.
You must get into the habit of considering non-financial and qualitative factors in any decision.
Many exam questions will specifically ask you to do so.