BREAK EVEN ANALYSIS

GROUP MEMBERS Nikhil Das M Gopi Nath Lalitha Ashok Mahindran Don

CONTENTS

definition

Purpose

Construction/Computation

Margin of safety

Types of costs

Break even analysis

Limitations

Available calculators for calculating BEP

conclusion

DEFINITION

“Break even point (BEP) is the point at which cost or expenses and revenue are equal”

There is no net loss or gain

All cost that need to by paid by the firm are paid but the profit remains “zero”

Break Even Point (IN UNIT)= Fixed Cost /S. Price- Variable Unit Cost

Break Even Point (in Rs)=Fixed Cost/ S. Price-Variable unit Cost*Units

XYZ co. ltd1000 tables ( break even)More than 1000 tables( profit )Less than 1000 tables(loss)

Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control of telephone bills or other costs)

Try to reduce variable costs (the price it pays for the tables by finding a new supplier)

Increase the selling price of their tables

Alternate option

Example:

The purpose of break-even analysis is to provide a rough indicator of the earnings impact of a marketing activity.

The break-even point is one of the simplest yet least used analytical tools in management.

It helps to provide a dynamic view of the relationships between sales, costs, and profits

The break-even point is a special case of Target Income Sales where Target Income is 0 (breaking even).

This is very important for financial analysis.

purpose

Computation /construction of BEP

LINEAR COST-VOLUME-PROFIT ANALYSIS MODEL

Where, marginal cost and marginal revenue are constant BEP can be directly computed in terms of total revenue(TR) and total cost (TC)

.

X is BEP (in terms of unit sales)

TFC is Total Fixed Cost

P is Unit Sale Price

V is Unit Variable Cost

Alternative method

Where,

Contribution equals Fixed Cost

Total Contribution=Total Fixed Costs

Unit Contribution X Number Of Units=Total Fixed Costs

Number Of Units= Total Fixed Costs Unit Contribution

MARGIN OF SAFETY

Margin of safety represents the strength of the business

It enables a business to know what is the exact amount it has gained or lost and whether they are over or below the break-even point

Margin of safety = (current output - breakeven output)

Margin of safety% = (current output - breakeven output)/current output × 100

FORMULA

Break-Even AnalysisCosts/Revenue

Output/Sales

FC

VC

TCTR (p = £2)

Q1 Q2

Assume current sales at Q2

Margin of Safety

TR (p = £3)

Q3

A higher price would lower the break even point and the margin of safety would widen

Important things to be considered before conducting break- even analysis

FIXED COST

VARIABLE COST

SETTING PRICE

PHYCHOLOGY OF PRICING

PRICING METHODS

BREAK-EVEN ANALYSISCosts/Revenue

Output/Sales

Initially a firm will incur fixed costs, these do not depend on output or sales.

FC

As output is generated, the firm will incur variable costs – these vary directly with the amount produced

VC

The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC

TCTotal revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially.

TR The lower the price, the less steep the total revenue curve.

TR

Q1

The Break-even point occurs where total revenue equals total costs – the firm, in this example would have to sell Q1 to generate sufficient revenue to cover its costs.

Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VCTCTR (p = £2)

Q1

If the firm chose to set price higher than £2 (say £3) the TR curve would be steeper – they would not have to sell as many units to break even

TR (p = £3)

Q2

Break-Even AnalysisCosts/Revenue

Output/Sales

FC

VCTCTR (p = £2)

Q1

If the firm chose to set prices lower (say £1) it would need to sell more units before covering its costs

TR (p = £1)

Q3

example, suppose that your fixed costs for producing 100,000 product were 30,000 rs a year.

Your variable costs are 2.20 rs materials, 4.00 rs labour, and 0.80 rs overhead, for a total of 7.00 rs per unit.

If you choose a selling price of 12.00 rs for each product, then:30,000 divided by (12.00 - 7.00) equals 6000 units.

This is the number of products that have to be sold at a selling price of 12.00 rs before your business will start to make a profit.

LIMITATIONS

•Break-even analysis is only a supply-side (i.e., costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.

•It assumes that fixed costs (FC) are constant. Although this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise.

•It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e., linearity).

In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).

It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period).

CALCULATORS

Case Western Reserve University offers a breakeven analysis calculator that includes a review of relevant microeconomic terms.

financial calculator allows you to chart your costs and profits appear in a graph.

Inc.com offers a breakeven analysis calculator that requires a user to enter in total annual overhead and annual year-to-date sales and cost of sales, and lets the user delineate the period for the YTD calculations in terms of weeks

CONCLUSION

“Breakeven analysis is not a predictor of demand, so if you go into market with the wrong product or the wrong price, it may be tough to ever hit the breakeven point”