BREAK EVEN ANALYSIS C.V.P.

. ANALYSIS Break-Even-Analysis : Break Even Analysis is an important technique to study the Cost Volume Profit relationship. It is useful to analyse the effect on profit of change in volume of production or cost or sales. BEA is interpreted in narrow sense as well as in broad sense. In its narrow sense, BEA is concerned with determining Break Even Point (BEP) i.e. that level of production and sales where there is no profit or no loss. At this point, total cost is equal to total sales revenue or contribution is equal to fixed cost. If sales increases beyond the break even, there shall be profit to the organization and if it decreases, there shall be loss to the organization. Beyond BEP, it is the study of CVP relationship. In its broad sense, BEA is used to determine probable profit or loss at any given level of production or sales. Break Even Analysis can be used for the following purposes. 1. To ascertain the amount of profit or loss at any level of activity. 2. To study the effect of changes in volume of sales, selling price of product, variable cost or fixed cost on profit. 3. To determine costs and revenues at various levels of activity. 4. To determine the sales volume to earn desired amount of profit. 5. To suggest the change in sales mix for obtaining maximum profits. 6. To determine the margin of safety. 7. To compare profitability among products and firms. Break Even Analysis is based on a number of assumptions: 1. All costs can be segregated into fixed cost and variable cost. 2. Variable Cost per unit remains constant at all levels of output. 3. Total fixed cost remains constant at all levels of output. 4. Selling price per unit remains constant at all levels of output. 5. Only one product is produced. In case of multiple products, sales-mix of various products remains unchanged. 6. Units produced and sold are same and so there is no opening stock or closing stock. Margin of Safety : MS : MS is the difference between actual sales and BES. Sales beyond Break Even are MS-Sales (MSS) All fixed costs are recovered fully at BEP so Fixed Costs have been excluded from the formula of MSS. The formula for MSS is as follows : MSS : Profit PVR If MS is large, it indicates strength of the business because with substantial reduction in sales or production, profit can still be made. If MS is small, a small reduction in sales or production will be a serious matter and lead to loss. Angle of Incidence : The angle of incidence is the angle between the sales line and total cost line formed at the BEP where the sales line and total cost line intersect each other. The angle of incidence indicates the profit earning capacity of a business. A large angle of incidence indicates a high rate of profit and a small angle of incidence indicates a low rate of profit. Usually, the angle of incidence and margin of safety are considered together to indicate the soundness of the business. A large angle of incidence with a high margin of safety indicates the most favorable position of a firm Marginal cost: Marginal cost is the additional cost of producing an additional unit of product. It is the total of all variable costs. It is composed of all direct costs and variable overheads. Marginal Costing : Marginal costing is the technique of ascertaining marginal cost by differentiating between fixed cost and variable cost and of the effect on profit of change in volume of output. In marginal costing it is assumed that there are only two types of costs i.e. fixed cost and variable cost.

Characteristics of Marginal Costing :

1. Segregation of costs into fixed and variable elements : Total costs are divided into fixed cost and
variable cost elements. Semi-variable or Semi-fixed costs are also divided into fixed cost and variable cost. The fixed portion is added to other fixed cost and variable portion is added to other variable costs thus arriving at total fixed cost and total variable costs.

2. Variable costs as Product Cost : Variable cost is Product Cost and charged to product. Only variable
cost is included in closing stock of WIP and FG. It is carried over from one period to another period.

3. Fixed Costs as Period Cost : Fixed Cost is Period Cost and charged to Costing Profit & Loss Account
if it is not recovered. Fixed cost does not carry forward to next period/year through closing stock.

4. Profit is calculated by two stage approaches : First, contribution is ascertained by deducting variable
cost from income from sales of each department or production. The contribution of different departments is then pooled together and such total contribution is called Funds. From this total amount of funds, the total fixed cost of the firm is then deducted to find out net profit or net loss. In case of a firm where there are no departments or no multi-products produced, the simple marginal cost statement of ascertaining profit or loss shown above is used. In case of a firm where there are different departments or multi-products are produced, department wise or product wise marginal cost statement of ascertaining profit or loss shown below is prepared. Marginal Cost Statement (with different Departments) Particulars Sales Less : Variable Cost Contribution Less : Fixed Cost Profit Department-A **** **** **** Department-B **** **** **** Department-C **** **** **** Total ****** ****** ****** (Funds) ****** ******

5. Contribution : Contribution is the difference between sales value and marginal cost of sales. The
relative profitability of different departments or products is based on a study of contribution made by each department or products.

6. Price : Prices are determined on the basis of marginal cost (variable cost) by adding contribution which
is the excess of sales over marginal contribution of sales.

7. Relationship between contribution and sales : There is direct relationship between contribution and
sales. There is no direct relationship between net profit and sales. 2. Profit Volume Ratio : PVR : The PVR is the ratio of contribution to sales, generally expressed in terms of percentage. It can also be expressed as the ratio of the sum of fixed costs and profit to sales. PVR may also be computed by comparing the change in contribution with change in sales (or change in profit with change in sales). Any increase in profit will mean increase in contribution because fixed costs are assumed to remain constant at all levels of production. Uses of PVR : PVR is very useful in taking a number of managerial decisions. It is an indicator of the rate at which profit is being earned. A high PVR indicates high profitability and a low ratio indicates low profitability in the business. The profitability of different sections of the business such as sales area, classes of customers, product lines, methods of production etc. may also be compared with the help of PVR.