Break-even analysis

The difference between price and

average variable cost is defined as
profit contribution (P- AVC)
 At low rates of output, profit
contribution is used to cover fixed costs
 After fixed costs are covered, firm will
be earning profit
 Profit is the difference between total
revenue and the sum of total variable
cost and fixed costs
 Symbolically as follows
 Profit= PQ – {(Q*AVC)+FC}
 What is the rate of output “Q” to
generate a specified rate of profit
 Q= FC + Profit
 ---------------
 P – AVC
 Where FC = 10000, P = 20, AVC = 15
 Profit target = 20000
To generate the profit of
20000, calculate the required
rate of output

 Rs10000+Rs20000 = 6000
 Rs20 –Rs 15
 The break even output
 Qe = FC = 10000 = 2000
 P - AVC 20-15
 The out put rate that yields a specified
rate of economic profit is found by
dividing the required profit plus total
fixed cost by profit contribution
 Break even analysis is a special case of
required profit analysis where the
required profit is zero
 Break even out put occurs at the
meeting point between total cost
function and total revenue function
 Total cost function is TC = 10000+15Q
 Total revenue function = 20Q
 Profit = the area above break even
point
 Loss = the area below break even point
 revenue
 The main objective of break even analysis is
not simply to spot BEP, but to develop an
understanding of the relationship between
cost, price and volume within a company’s
range of operations.
 The break even chart is an excellent
instrument panel for guidance in controlling
business interest
Managerial uses of break even
analysis
 To know safety margin
 =(sales-BEP)*100
 sales
 The safety margin refers to the extent
to which the firm can afford a decline in
sales before it starts incurring losses
 To understand target profit
 Target sales volume
 = fixed costs+target profit
 contribution margin per unit
 To know change in price, change in cost
 To expand capacity or not
 To drop or add a decision
 To choose product mix
 To conduct equipment selection
 To increase volume of sales
 To improve profit performance
 To conduct production planning
problem
 A manufacturer sells his product @.Rs.5 each
 Variable cost : Rs2 /- per unit
 Fixed cost : Rs 60000
 calculate the break even point
 what would be the profit, if the firm
 sells 30000 units

 What would be the BEP if the firm
spends Rs. 3000 on advertising?
 How much should the manufacturer sell
to make a profit of Rs.30000 after
spending Rs.3000 advertisement?
 Solution
 (1) BEP: FC
 SP-VC
 60000 = 20000
 5-2
 (2) Profit = Total Revenue – FC- VC
 = (5*30000) – 60000 – (2*30000)
 = 150000 – 60000 – 60000
 = 30000
 if the firm spends Rs3000 on
advertising fixed costs would rise by
Rs.3000 I.e rs.63000
 BEP= (63000)/(5-2) = 21000
 Target sales volume
 = (FC+TP)/(SP-VC)
 = (63000+30000)/3 = 31000 units