Break Even Analysis

Break-even Analysis
 It is an economic concept that is used to determine the number of units that
needs to be sold by the company to cover the costs and gain no profits.
 It is the level of units that a company should at least reach in order to survive
in the market.
 Break-even is a level where a company neither earns any profits nor suffers
any losses.
 Basically, the break-even point tells us the units to be sold in order to cover
costs.
Components of Break-even Analysis
The three components of Break-even Analysis are as follows:

1. Fixed Costs:
 These are the costs that the company has to bear even when there is no
production of units.
 Fixed costs remain constant and do not change with the level of production.
 Fixed Costs are also known as Overhead Costs.
For example, Rent or mortgage, equipment costs, salaries, taxes, insurance
premiums, etc.
2. Variable Costs:
 Variable Costs are the costs that change with the change in output.
 Variable Costs rise as the production rises and falls when production falls.
 These costs include packaging costs, wages, cost of raw materials, etc.

3. Selling Price:
 Selling price is the amount that the seller/company charges the customers in
exchange for their product or services.
 The selling price is determined on the basis of raw materials used for
production, wages, fixed expenses, etc.
Assumptions of Break even Analysis:

(i)The total costs may be classified into fixed and variable costs. It ignores
semi-variable cost.

(ii) The cost and revenue functions remain linear.

(iii) The price of the product is assumed to be constant.

(iv) The volume of sales and volume of production are equal.

v) The fixed costs remain constant over the volume under consideration.

(vi) It assumes constant rate of increase in variable cost.

(vii) It assumes constant technology and no improvement in labour efficiency.

(viii) The price of the product is assumed to be constant.

(ix) The factor price remains unaltered.

(x) Changes in input prices are ruled out.

(xi) In the case of multi-product firm, the product mix is stable.

Limitations of Break-Even Analysis:

1. In the break-even analysis, we keep everything constant. The selling price is

assumed to be constant and the cost function is linear. In practice, it will not be
so.
2. In the break-even analysis since we keep the function constant, we project the
future with the help of past functions. This is not correct.
3. The assumption that the cost-revenue-output relationship is linear is true only
over a small range of output. It is not an effective tool for long-range use.
4. Profits are a function of not only output, but also of other factors like
technological change, improvement in the art of management, etc., which have
been overlooked in this analysis.

5. When break-even analysis is based on accounting data, as it usually happens,

it may suffer from various limitations of such data as neglect of imputed costs,
arbitrary depreciation estimates and inappropriate allocation of overheads. It can
be sound and useful only if the firm in question maintains a good accounting
system.
6. Selling costs are specially difficult to handle break-even analysis. This is
because changes in selling costs are a cause and not a result of changes in
output and sales.

7. The simple form of a break-even chart makes no provisions for taxes,

particularly corporate income tax.

8. It usually assumes that the price of the output is given . In other words, it
assumes a horizontal demand curve that is realistic under the conditions of
perfect competition.
9. Matching cost with output imposes another limitation on break-even analysis.
Cost in a particular period need not be the result of the output in that period.

10. Because of so many restrictive assumptions underlying the technique,

computation of a break­even point is considered an approximation rather than a
reality.
Calculation of Break-even Point:

The break-even point is calculated using the selling price per unit, variable
costs, and fixed costs.
Break-Even Quantity = Fixed Costs
(Sales Price per Unit – Variable Cost Per Unit)
 Example:

Particulars Amount (in ₹)

Fixed Expense 2,00,000
Variable Expenses 4/unit
Selling Price 24

BEP= FC/( Sales price per unit- VC per unit)

BEP= 2,00,000/(24-4)
BEP= 10,000
It means that the company would need to sell 10,000 units of the product to attain
break-even.
Problems:
1. KSRTC has a capacity to carry a maximum of 10,000 passengers per month
from Bangalore to Hyderabad at a fare of Rs. 600. Variable costs are Rs.100
per passenger and fixed costs are Rs. 30,000 per month. How many
passengers should be carried per month to break-even.
Solution:
BEP= FC/( Sales price per unit- VC per unit)
= 30,000/(600- 100)
= 30,000/(500)
= 60
Therefore, 60 Passengers should be carried per month to break even
2. A small firm incurs fixed expenses amounting to Rs. 1.2 lakhs. Its variable cost
of production is Rs. 5 per unit and selling price is Rs. 8. Determine its Break-even
quantity and safety margin for the sales of 50,000.
Solution: FC = Rs 1,20,000
VC = Rs. 5
Selling Price= Rs. 8

BEP = FC/(SP- VC)

= 1,20,000/(8-5)
= 1,20,000/(3)
= 40,000 Units
Margin of safety= Total sales – Sales at Break Even
= 50,000- 40,000
= 10,000 Units
3. Calculate the break-even point from the following data:
Sales= 550 Units
Sales receipt = Rs. 28,875
Total fixed cost = Rs. 16,000
Variable Cost = Rs. 11,000
Solution:
BEP = Total Fixed Cost x Sales receipt
Sales receipt- Variable Cost

= 16,000 X 28,875 = 46,20,000 = Rs. 25,846

( 17,875) ( 28,875- 11,000)
4. Two businesses, AB Ltd, sell the same type of product in same type of market.
Their budgeted profit and loss accounts for current year ending March 31 are
as follows
Particulars AB Ltd (Rs) CD Ltd (Rs)
Sales 150000 150000
Less: Variable 12000 100000
Costs
Fixed Costs 15000 135000 35000 135000
Net budgeted 15000 15000
Profit

You are required to calculate the break even points of each business
Solution:
BEP (Amount) = FC / (P/V ratio)
P/V ratio = Contribution/ Sales revenue
= 30,000/1,50,000
= 0.2
BEP ( AB Ltd) = 15,000/ 0.20
= Rs. 75,000
BEP (Amount) = FC / (P/V ratio)
P/V ratio = Contribution/ Sales revenue
= 50,000 / 1,50,000
= 0.33
BEP ( AB Ltd) = 35,000/ 0.33
= 1,05,000
5. PCT Ltd , provide you the following information for the year ending 31 st March
2008
Normal capacity - 2000 units
Production and sales – 2000 units
Selling price per unit – Rs. 10
Direct material – Rs . 2000
Direct wages- Rs. 2000 and direct Expenses – Rs.1600
Factory Overheads (15% Variable) – Rs. 4000
Office and Admn Expenses (80 % Fixed) – Rs. 4000
Selling and Distribution expenses (75% fixed) – Rs. 4000
Calculate the following:
1. P/ V ratio
2. Break - even point (in Units)
3. Break- even point (in Rs)
4. Break- even point (in %)
5. Margin of safety (in units)
6. Margin of safety (in Rs)
7. Margin of safety (in %)
Solution:
1. P/ V ratio = Contribution X 100 = 12,000 X100 = 60%
Sales 20,000

2. BEP (Units) = Fixed Cost = 9600/ 6 = 1,600 Units

Contribution per unit

3. BEP( in Value) = Fixed Cost = 9600/ 60% = Rs. 16,000

P/V Ratio

4. BEP ( in % of sales) = BEP ( in units) X 100

Actual sales ( in Units)

= 1600 X 100 = 80%

2000
5. Margin of safety ( in units) = Actual sales ( in Units)- BEP (in units)
= 2,000 Units – 1,600 Units
= 400 Units
6. Margin of safety ( in Rs) = Sales( in Value) – BEP (in Value)
= 20,000- 16,000
= 4,000 Rs
7. Margin of safety (in % of sales) = Actual sales (in units) – BEP ( in units) X 100
Actual Sales ( in Units)
= 2,000- 1,600 x 100 =20%
2,000