BREAK EVEN ANALYSIS

Books Referred : Managerial Economics By P.N.Chopra By Dr. Raj Kumar Prof. Kuldip Gupta

Break Even Analysis

It studies the relationship between the volume and cost of production on the one hand, and the revenue and profits obtained from the sales on the other. According to Martz, Curry and Frank, A BreakEvan Analysis indicates at what level cost and revenue are in equilibrium. In break even analysis, the role of break even point is of particular importance.

The Break-Even Point is the point at which total revenue and total costs are equal. It is the point of zero profit.

Assumptions of Break-Even analysis

It assumes that costs can be classified into fixed and variable costs. It ignores semi-variable costs. Total Revenue is assumed to be variable with the physical volume of production. The price of the product is assumed to be constant. It assumes constant technology and no improvement in labour efficieny as ouptut rises or falls.

The Break-Even Chart

A Break Even Chart may be defined as an analysis in graphic form of the relationship of production and sales to profits.

Alternatives to explain Break-Even Analysis

Break Even Point in units QB = TFC (P-AVC) Break Even Point in Sales SB = TFC 1-TVC TR

3. Break Even Point in Percentage In order to determine the break even point in terms in percentage utilisation of plant capacity (%B) the equation : %B= TFC (P-AVC)*Q(Cap) Cap = capacity

Methods of break even Analysis

Graphic method
Break Even Chart can be used to explain the break even point under Graphic Method. The Break Even Chart shows the extent of profit or loss to the firm at different levels of activity.

2. Contribution Margin Method

In the short run, where many of the firms costs are fixed, businessmen are often interested in determining the contribution additional sales make towards fixed costs and profits. Contribution analysis provides this information. Contribution profit analysis provides a useful format for examining a variety of price and output decisions. Total Contribution Profit (TCP) = Total Revenue (TR) Total Variable Cost (TVC) = Total Net Profit (TNP) + Total Fixed Cost (TFC)

3. Algebraic Method

Break Even Analysis can also be performed algebraically, as follows. TR = (P).(Q) TC=TFC+TVC TC=TFC+(AVC).(Q) Substituting Q with QB (Break Even Output), we have TR=TC (P).(QB )

Advantages of Break Even Analysis

Simple to operate and easy to understand Helps the management in production planning Facilitates calculation of important factors like Break Even Point Valuable aid to management for decision-making Facilitates study of relative profitability

Helps in Cost control Profit Planning Management reporting (MBE i.e Management by Exception)

Limitations of Break Even Analysis

Based on Past Data Price remains constant Assumption of profits depend on output alone Ignores selling costs and concentrates only on production costs It is an effective tool only for short-run forecasts Variables included in break even analysis should be limited Not a unique cost control technique : Cost control can better be achieved with the help of other techniques like standard costing, budgetary control etc.