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http://www.accountingformanagement.com/Break_even_analysis.htm Learning Objectives: 1. Define and explain break even point. 2. How is it calculated? 3. What are its advantages, assumptions, and limitations?
1. 2. 3. 4. 5. 6. 7. 8.
Definition of Break Even Point Calculation by Equation Method Calculation by Contribution Margin Method Advantages / Benefits of Break Even Analysis Assumptions of Break Even Point Limitations of Break Even Analysis Review Problem Break Even Analysis Calculator
Equation Method:
The equation method centers on the contribution approach to the income statement. The format of this statement can be expressed in equation form as follows: [Profit = (Sales Variable expenses) Fixed expenses] Rearranging this equation slightly yields the following equation, which is widely used in cost volume profit (CVP) analysis: [Sales = Variable expenses + Fixed expenses + Profit] According to the definition of break even point, break even point is the level of sales where profits are zero. Therefore the break even point can be computed by finding that point where sales just equal the total of the variable expenses plus fixed expenses and profit is zero.
Example:
For example we can use the following data to calculate break even point.
Sales price per unit = $250 variable cost per unit = $150 Total fixed expenses = $35,000
Calculation:
Sales = Variable expenses + Fixed expenses + Profit $250Q* = $150Q* + $35,000 + $0** $100Q = $35000 Q = $35,000 /$100 Q = 350 Units
Q* = Number (Quantity) of units sold. **The break even point can be computed by finding that point where profit is zero
The break even point in sales dollars can be computed by multiplying the break even level of unit sales by the selling price per unit. 350 Units $250 Per unit = $87,500
A variation of this method uses the Contribution Margin ratio (CM ratio) instead of the unit contribution margin. The result is the break even in total sales dollars rather than in total units sold. Break even point in total sales dollars = Fixed expenses / CM ratio $35,000 / 0.40 = $87,500
This approach is particularly suitable in situations where a company has multiple products lines and wishes to compute a single break even point for the company as a whole. The following formula is also used to calculate break even point Break Even Sales in Dollars = [Fixed Cost / 1 (Variable Cost / Sales)] This formula can produce the same answer: Break Even Point = [$35,000 / 1 (150 / 250)] = $35,000 / 1 0.6 = $35,000 / 0.4 = $87,500
3. Monthly fixed costs: Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses). This will give you a better insight on financial realities. If averaging and estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimateit will be a rough estimate, but it will provide a useful input for a conservative Breakeven Analysis.
Review Problem:
Voltar Company manufactures and sells a telephone answering machine. The company's contribution format income statement for the most recent year is given below: Total Sales Less variable expenses Contribution margin Less fixed expenses Net operating income $1,200,000 900,000 -------300,000 240,000 -------$60,000 ====== Per unit $60 45 -------15 ====== Percent of sales 100% ?% -------?% ======
Calculate break even point both in units and sales dollars. Use the equation method.
Solution:
Sales = Variable expenses + Fixed expenses +Profit $60Q = $45Q + $240,000 + $0 $15Q = $240,000 Q = $240,000 / 15 per unit Q = 16,000 units; or at $60 per unit, $960,000 Alternative solution: X = 0.75X + 240,000 + $0
0.25X = $240,000 X = $240,000 / 0.25 X = $960,000; or at $60 per unit, 16,000 units