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Break Even Analysis

The document discusses break-even analysis, which is used to determine the production volume at which a firm will make a profit. It defines key terms like total sales, total costs, break-even point, break-even quantity, contribution, and margin of safety. Formulas are provided to calculate break-even quantity, break-even sales, contribution, and margin of safety. Examples are included to demonstrate calculating these metrics using financial data for different companies.

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Nafi Ahmed
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349 views

Break Even Analysis

The document discusses break-even analysis, which is used to determine the production volume at which a firm will make a profit. It defines key terms like total sales, total costs, break-even point, break-even quantity, contribution, and margin of safety. Formulas are provided to calculate break-even quantity, break-even sales, contribution, and margin of safety. Examples are included to demonstrate calculating these metrics using financial data for different companies.

Uploaded by

Nafi Ahmed
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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BREAK-EVEN ANALYSIS

The main objective of break-even analysis is to find the cut-off production volume from where a
firm will make profit. Let
s = selling price per unit
v = variable cost per unit
FC = fixed cost per period
Q = volume of production
The total sales revenue (S) of the firm is given by the following formula:
S=s×Q
The total cost of the firm for a given production volume is given as
TC = Total variable cost + Fixed cost
= v × Q + FC

The linear plots of the above two equations are shown in Fig. 1.

Fig. 1: Break-even chart.


The intersection point of the total sales revenue line and the total cost line is called the break-even
point. The corresponding volume of production on the X-axis is known as the break-even sales
quantity. At the intersection point, the total cost is equal to the total revenue. This point is also
called the no-loss or no-gain situation. For any production quantity which is less than the break-
even quantity, the total cost is more than the total revenue. Hence, the firm will be making loss.

For any production quantity which is more than the break-even quantity, the total revenue will be
more than the total cost. Hence, the firm will be making profit.
Profit = Sales – (Fixed cost + Variable costs)
= s × Q – (FC + v × Q)
The formulae to find the break-even quantity and break-even sales quantity
(Fixed cost)
Break-even quantity = (Selling price/unit − Variable cost/unit)
F.C
= s−v (in units)

(Fixed cost)
Break-even sales = (Selling price/unit − Variable cost/unit) × Selling price/unit
F.C
= s−v × s (Rs.)

The contribution is the difference between the sales and the variable costs. The margin of safety
(M.S.) is the sales over and above the break-even sales. The formulae to compute these values are
Contribution = Sales – Variable costs
Contribution/unit = Selling price/unit – Variable cost/unit
M.S. = Actual sales – Break-even sales
Profit
= 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 × sales

M.S. as a per cent of sales = (M.S./Sales) × 100

EXAMPLE -1: Alpha Associates has the following details:


Fixed cost = Rs. 20,00,000
Variable cost per unit = Rs. 100
Selling price per unit = Rs. 200
Find
(a) The break-even sales quantity,
(b) The break-even sales
(c) If the actual production quantity is 60,000, find (i) contribution; and (ii) margin of safety by
all methods.

Solution
Fixed cost (FC) = Rs. 20,00,000
Variable cost per unit (v) = Rs. 100
Selling price per unit (s) = Rs. 200
(Fixed cost)
(a) Break-even quantity = (Selling price/unit − Variable cost/unit)
20,00,000
= 200−100

= 20,000 units
(Fixed cost)
(b) Break-even sales = (Selling price/unit − Variable cost/unit) × Selling price/unit
20,00,000
= 200−100 × 200

= Rs. 40,00,000
(c) (i) Contribution = Sales – Variable cost
=s×Q–v×Q
= 200 × 60,000 – 100 × 60,000
= 1,20,00,000 – 60,00,000
= Rs. 60,00,000
(ii) Margin of safety
METHOD I
M.S. = Sales – Break-even sales
= 60,000 × 200 – 40,00,000
= 1,20,00,000 – 40,00,000
= Rs. 80,00,000
METHOD II
Profit
M.S. = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 × sales

Profit = Sales – (FC + v × Q)


= 60,000 × 200 – (20,00,000 + 100 × 60,000)
= 1,20,00,000 – 80,00,000
= Rs. 40,00,000

40,00,000
M.S. = 60,00,000 × 1,20,00,000 = Rs. 80,00,000
80,00,000
M.S. as a per cent of sales = 1,20,00,000 × 100 = 67%

PROFIT/VOLUME RATIO (P/V RATIO)


P/V ratio is a valid ratio which is useful for further analysis. The different formulae for the P/V
ratio are as follows:
Contribution Sales−Variable Cost
P/V ratio = =
𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠
The relationship between BEP and P/V ratio is as follows:
Fixed Cost
BEP =
𝑃/𝑉 ratio

The following formula helps us find the M.S. using the P/V ratio:
Profit
M.S. =
𝑃/𝑉 ratio

EXAMPLE -2: Consider the following data of a company for the year 2015:
Sales = Rs. 1,20,000
Fixed cost = Rs. 25,000
Variable cost = Rs. 45,000
Find the following:
(a) Contribution
(b) Profit
(c) BEP
(d) M.S.

Solution
(a) Contribution = Sales – Variable costs
= Rs. 1,20,000 – Rs. 45,000
= Rs. 75,000
(b) Profit = Contribution – Fixed cost
= Rs. 75,000 – Rs. 25,000
= Rs. 50,000
(c) BEP
Contribution
P/V ratio =
𝑆𝑎𝑙𝑒𝑠
75,000
= ×100 = 62.5%
1,20,000

Fixed Cost 25,000


BEP = = ×100 = Rs. 40,000
𝑃/𝑉 ratio 62.5

(d) M.S.
Profit 50,000
M.S. = = ×100 = Rs. 80,000
𝑃/𝑉 ratio 62.5

EXAMPLE -3: Consider the following data of a company for the year 2014:
Sales = Rs. 80,000
Fixed cost = Rs. 15,000
Variable cost = 35,000
Find the following:
(a) Contribution
(b) Profit
(c) BEP
(d) M.S.

Solution
(a) Contribution = Sales – Variable costs
= Rs. 80,000 – Rs. 35,000
= Rs. 45,000
(b) Profit = Contribution – Fixed cost
= Rs. 45,000 – Rs. 15,000
= Rs. 30,000
(c) BEP
Contribution
P/V ratio =
𝑆𝑎𝑙𝑒𝑠
45,000
= ×100 = 56.25%
80,000

Fixed Cost 15,000


BEP = = ×100 = Rs. 26,667
𝑃/𝑉 ratio 56.25

(d) M.S.
Profit 30,000
M.S. = = ×100 = Rs. 53,333.33
𝑃/𝑉 ratio 56.25

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