Break Even analysis power point presentation

Break even analysis

1. BREAK EVEN ANALYSIS Ø  Business is faced with a number of uncertainties Ø  created by the dynamic nature of consumer needs, Ø   the diverse nature of competition, Ø  The uncontrollable nature of most elements of cost, and Ø  the continuous technological development.

2. Ø        A healthy business has to make profit consistent with the various risks that it has to face. Ø       The business has, therefore, to be prepared to face the uncertainties created by these risks, and firm has to plan for profits and not left to chance. Ø       In this respect a thorough understanding of the relationships of costs, price and volume is extremely helpful. Ø      Break-even analysis or cost-volume-profit (CVP) analysis is the most important method for this purpose.  

3. Break-even point (BEP) Ø   Defined as that level of sales at which total revenues equal total costs and the net income is zero. This is also known as no-profit no-loss point.   Determination of Break-even point : It be determined either in terms of sales volume (units) or sales value (Rupees) Break-even point in terms of sales volume or physical units: Break-even volume is the number of physical units of product which must be sold to earn revenue just enough to cover all costs- fixed and variable.

4. Ø       The selling price covers not only the variable costs but also leaves a margin (contribution margin) to contribute towards the fixed costs. Ø       The break-even point is reached when sufficient number of units have been sold so that the contribution margin of the units is equal to the fixed costs. Ø       Method is convenient for single product.   Break-even point = Fixed cost Contribution margin per unit Where,  Contribution margin = sale price – variable cost per unit

5. Ex. 1: Given that (a)    fixed cost = Rs. 10000 per year, (b)   Variable cost = Rs. 2.00 per unit and (c)    sale price = Rs. 4.00 per unit, (d)   calculate the BEP.

6. Solution:   Contribution Margin per unit =Sales price – variable cost per unit = Rs. 4.00- Rs. 2.00 = Rs. 2.00 Break-even point = Fixed cost/ Contribution Margin per unit = 10,000/ 2= 5,000 unit.   At this sales volume there will be no profit or loss .

7. Break-even point in terms of sales value   Multi-product firms cannot measure b. e. p. in terms of sales volume but in terms of total value of sales i.e. rupee sales. Here again, the breakeven point would be the point where the contribution margin ( sales value – variable costs) would equal the fixed costs. Contribution margin is, however, as ratio to sales. If sales are Rs. 200, and variable costs for these sales is Rs. 140, the contribution ratio will work out to [(200-140}/200] 0.3

8. Break-even point = Fixed cost Contribution ratio Where,  Contribution ratio = [(sales – variable costs)/sales]

9. Example 2 : Given sales= Rs. 10,000, variable costs= Rs. 6000 and fixed costs=Rs. 3000 calculate breakeven point. Solution:   Contribution ratio = [(sales – variable costs)/sales] = (10,000-6,000)/10,000 = 0.4 Break-even point = Fixed costs/ contribution ratio = 3,000/0.4= Rs. 7,500

10. Example 3 :   Sales of Rs. 15,000 provide a profit of Rs. 400 in a week. In the next week, sales amounted to Rs. 19,000 and profit was Rs. 1200. Find B. E. P.  

11. Solution:   Increase in Sales = Rs. 19,000- 15,000 = Rs. 4,000 Increase in profit = Rs. 1200- 400 = Rs. 800 Increase in variable cost= Rs. 4,000 – 800 = Rs. 3,200 So, for sales of Rs. 4,000, the variable cost = Rs. 3200 Or, Variable cost per unit = 3,200/4,000 = Rs. 0.8

12. Hence, for a given sales of Rs. 15,000 variable cost can be worked out as under:   Variable cost = Rs. 15,000 x 0.8 = 12,000 Profit = Rs. 400 Variable cost +Profit = Rs. 12,400 Sales Value = Rs. 15,000 Fixed Cost = sa0les value-v. c.–profit =Rs. 15,000- 12,400 =Rs. 2,600

13. Contribution ratio= (Sales- V.C. )/ Sales = Rs. (15,000-12,000)/15,000 =3,000/15,000 =0.2   Break-even point =F.C./Contribution ratio =2,600/0.2 =Rs. 13,000  

14. Break-even point as a percentage of full capacity  Full capacity may be defined as the maximum possible volume of production available with the firm’s existing fixed assets, operating policies and practices. Break-even point is usually expressed as a percentage of full capacity. Supposing full capacity in example 1 is 10,000 units, the B. E. P. at 5,000 units can be expressed as 50% of full capacity.

15. Multi-product manufacturing and Break-even Analysis   Example 4: A manufacturer manufactures tables, chairs and lamps. The cost accounting department has supplied the following data: Product Selling price p.u. v.c. p.u. % of rupee sales value Tables 40 30 20 Lamps 50 40 30 Chairs 70 50 50

16. Capacity of the firm Rs. 150,000 of total sales value Actual fixed cost Rs. 20,000 Calculate (1) Break-even point(2) Profit if firm works at 80% of capacity   Solution: The contribution towards fixed cost in each case is as follows:   Tables Rs. 10 Lamps Rs. 10 Chairs Rs. 20

17. The percentage contribution by each product works out as follows:   Contribution* 100/ selling price   Tables 10*100/40 = 25% Lamp 10*100/50= 20% Chairs 20*100/70= 28.57% Now, we multiply the contribution percentage of each product by the percentage sales volume for that particular product and add the figures so obtained. This gives the total contribution per rupee of sales volme for these products.

18. Product Contribution % % of sales Contribution % * % of sales Tables 25 20 5% Lamps 20 30 6% Chairs 28.57 50 14.28% Total 25.28% Say 25%

19. This 25% is the total contribution given the present sales mix per rupee of overall sales. (1)   Break-even point = Fixed Cost/ Contribution ratio = 20,000/ 25% = Rs. 80,000 (2)   Profit: If the produces 80% of its full capacity, assuming the same product mix, the profit can be calculated as under. Profit = Total Revenue – Total Cost = 80% of 150,000-Fixed cost- variable cost(=sales –contribution) =120,000-20,00-(100-25)% of 120,000 =120,000-20,000-90,000 =Rs 10,000

20. Break-even Charts The break-even analysis can also be done with the help of break-even charts.  A break-even chart based on Example 1 is given in Fig. 1. BEP corresponds to the point where Total revenue (TR) and Total cost (TC) intersect each other A perpendicular to X-axis from this point gives physical units of BEPA line perpendicular to the Y-axis gives BEP in rupees Quantity Y TR TC FC BEP O Costs/ Revenue X

21. Break-even chart – A variation Facing Fig. is a variation of traditional break-even chart This chart has been prepared With variable cost line starting at O. This graph shows more clearly the contribution to fixed cost and profit Quantity Y TR TC FC BEP O Costs/ Revenue VC PROFIT

22. It is similar to the break –even chart and is based on the analysis of the relationships of profit to sales volume. Total profit or loss is shown on Y-axis (profit above x-axis). The sales volume is measures on x-axis and is drawn at the point of ‘zero-profit’ Volume is usually expressed as Percentage of full capacity The maximum loss will be at zero Sales volume and is equal to the And is shown on Y-axis below the X-axis. The two points of maximum profit and maximum loss are joined together by a line which is known as ‘contribution line’. The point where, this line intersects the X-axis is the break-even point.

23. Sales Volume Q Y Y’ Profit Loss Contribution Line Loss Profit Maximum Profit Maximum Loss BEP

24. This graph shows at a glance the profit or loss earned by working at different levels of its full capacity. Assumptions underlying Break-even analysis All costs are either perfectly variable or fixed, which may not hold good during actual practice. All revenues are perfectly variable with physical volume of production. This may not hold good in many cases e.g. quantity discounts. Volume of sales and the volume of production are equal i.e. no change in the inventory. In practice they may differ significantly

25. In the case of a multi-product firm, the product mix should be stable. If different products have different contribution ratios, a shift in the product mix may shift the Break even point. In reality stability of product mix is unrealistic But, these limitations do not impair the usefulness of break-even analysis.

26. Managerial use of Break-even Analysis Ø       It presents a macroscopic picture of the profit structure of the business. Ø       It highlights areas of strengths and weaknesses. Ø       It sharpens focus on leverages which can be increase profitability. Ø       It is possible to examine profit vulnerability of a business conditions e.g. sales prospects, changes in cost structure etc.