Seacom Engineering

college
Continuous Assessment phase-II
Subject:- Economics for Engineers (HM-EE-601)

Name- Amit Kumar choudhary

Department: Electrical Engineering

Sem: 6th Roll No-20601621018

A) Break even analysis.

Ans: A break-even analysis is an economic tool that is used to determine the cost structure
of a company or the number of units that need to be sold to cover the cost. Break-even is a
circumstance where a company neither makes a profit nor loss but recovers all the money
spent.

The break-even analysis is used to examine the relation between the fixed cost, variable
cost, and revenue. Usually, an organisation with a low fixed cost will have a low break-even
point of sale.

Importance of Break-Even Analysis

• Manages the size of units to be sold: With the help of break-even
analysis, the company or the owner comes to know how many units need to be
sold to cover the cost. The variable cost and the selling price of an individual
product and the total cost are required to evaluate the break-even analysis.
• Budgeting and setting targets: Since the company or the owner knows at
which point a company can break-even, it is easy for them to fix a goal and set a
budget for the firm accordingly. This analysis can also be practised in establishing
a realistic target for a company.
• Manage the margin of safety: In a financial breakdown, the sales of a
company tend to decrease. The break-even analysis helps the company to decide
the least number of sales required to make profits. With the margin of safety reports,
the management can execute a high business decision.
• Monitors and controls cost: Companies’ profit margin can be affected by
the fixed and variable cost. Therefore, with break-even analysis, the management
can detect if any effects are changing the cost.
• Helps to design pricing strategy: The break-even point can be affected if
there is any change in the pricing of a product. For example, if the selling price is
raised, then the quantity of the product to be sold to break-even will be reduced.
Similarly, if the selling price is reduced, then a company needs to sell extra to break-
even.
Components of Break-Even Analysis
• Fixed costs: These costs are also known as overhead costs. These costs materialise
once the financial activity of a business starts. The fixed prices include taxes,
salaries, rents, depreciation cost, labour cost, interests, energy cost, etc.
• Variable costs: These costs fluctuate and will decrease or increase according to
the volume of the production. These costs include packaging cost, cost of raw
material, fuel, and other materials related to production.

Uses of Break-Even Analysis

• New business: For a new venture, a break-even analysis is essential. It guides
the management with pricing strategy and is practical about the cost. This analysis
also gives an idea if the new business is productive.
• Manufacture new products: If an existing company is going to launch a new
product, then they still have to focus on a break-even analysis before starting and see
if the product adds necessary expenditure to the company.
• Change in business model: The break-even analysis works even if there is a
change in any business model like shifting from retail business to wholesale business.
This analysis will help the company to determine if the selling price of a product
needs to change.

Break-Even Analysis Formula

Break-even point = Fixed cost/-Price per cost – Variable cost

Example of break-even analysis

Company X sells a pen. The company first determined the fixed costs, which
include a lease, property tax, and salaries. They sum up to ₹1,00,000. The
variable cost linked with manufacturing one pen is ₹2 per unit. So, the pen is
sold at a premium price of
₹10.
Therefore, to determine the break-even point of Company X, the premium pen will
be:
Break-even point = Fixed cost/Price per cost – Variable cost

= ₹1,00,000/(₹12 – ₹2)
= 1,00,000/10
= 10,000

Therefore, given the variable costs, fixed costs, and selling price of the pen,
company X would need to sell 10,000 units of pens to break-even.

The above-mentioned is the concept of ‘Break-Even Analysis’. To know more,

stay tuned to our website.
How Break-Even Analysis Works
Calculating the break-even analysis is useful in determining the level of production or a
targeted desired sales mix. The study is for a company's management use only,
as the metrics and calculations are not used by external parties, such as
investors, regulators, or financial institutions. This type of analysis involves a
calculation of
the break-even point (BEP). The break-even point is calculated by dividing the total
fixed costs of production by the price per individual unit, less the variable costs
of production. Fixed costs are costs that remain the same regardless of how
many units are sold.
Break-even analysis looks at the level of fixed costs relative to the profit earned
by each additional unit produced and sold. In general, a company with lower
fixed costs will have a lower break-even point of sale. For example, a company
with $0 of fixed costs will automatically have broken even upon the sale of the
first product, assuming variable costs do not exceed sales revenue.

Special Considerations
Although investors are not particularly interested in an individual company's
break- even analysis on their production, they may use the calculation to
determine at what price they will break even on a trade or investment.1 The
calculation is useful when trading in or creating a strategy to buy options or a
fixed-income security product.
Contribution Margin
The concept of break-even analysis is concerned with the contribution margin of
a product. The contribution margin is the excess between the selling price of the
product and the total variable costs. For example, if an item sells for $100, the
total fixed costs are $25 per unit, and the total variable costs are $60 per unit,
the contribution margin of the product is $40 ($100 - $60). This $40 reflects the
amount of revenue collected to cover the remaining fixed costs, which are
excluded when figuring the contribution margin.
Calculations for Break-Even Analysis
The calculation of break-even analysis may use two equations. In the first
calculation, divide the total fixed costs by the unit contribution margin. In the
example above, assume the value of the entire fixed costs is $20,000. With a
contribution margin of
$40, the break-even point is 500 units ($20,000 divided by $40). Upon the sale
of 500 units, the payment of all fixed costs are complete, and the company will
report a net profit or loss of $0.
Alternatively, the calculation for a break-even point in sales dollars happens by
dividing the total fixed costs by the contribution margin ratio. The contribution
margin ratio is the contribution margin per unit divided by the sale price.

Returning to the example above, the contribution margin ratio is 40% ($40
contribution margin per item divided by $100 sale price per item). Therefore, the
break-even point in sales dollars is $50,000 ($20,000 total fixed costs divided by
40%). Confirm this figured by multiplying the break-even in units (500) by the
sale price ($100), which equals $50,000.

Users of Break-Even Analysis

Break-even analysis is used by a wide range of entities, from entrepreneurs,
financial analysts, businesses and government agencies.
• Entrepreneurs: Break-Even analysis is useful for entrepreneurs and
founders because it helps determine the minimum level of sales needed
to cover costs. This is critical for the early stage of a business.
• Financial Analysts: These professionals use break-even analysis as a
profitability and risk metric. Financial Analysts tie break-even analysis
into their valuations and recommendations on a business.
• Investors: Investors conduct break-even analysis to determine the
financial performance of companies. With this information they make
more informed decisions on their asset selections.
• Stock and Option Traders: Break-even analysis is crucial for stock and
option traders because they need to know how much money is needed to
cover their expenses for each transaction they make. This analysis help
them determine how much money to allocate a transaction and which
assets would generate the higher profits for them.
• Businesses: A broad range of businesses use break-even analysis to
paint a better picture of their cost structure, pricing, as well as their
operational efficiencies.
• Government Agencies: Government agencies need to understand the
financial viability of projects and programs and they use break-even
analysis to determine this. It answers the question: What is the minimum
level of sales or revenue required to cover costs?
The Importance of Break-Even Analysis to Businesses
There are several reasons why break-even analysis is important to businesses.
They are as follows:
• Pricing: Businesses get a comprehensible perspective on their cost
structure with break-even analysis. With that understanding, businesses
 can set prices for their products that not only cover their fixed and variable
costs but provide a reasonable profit margin as well.
• Decision-Making: When it comes to new products and services,
operational expansion, or increased production, businesses can chart
their profit to sales

volume and use break-even analysis to help them make informed

decisions surrounding those activities.
• Cost Reduction: Break-even analysis helps businesses find areas where
they can reduce costs to increase profitability.
• Performance Metric: Break-even analysis is a financial performance
tool and helps businesses ascertain where they are when it comes to
achieving their short-, medium-, and long-term goals.
Limitations of Break-Even Analysis
Break-even analysis is a useful tool. However, like any tool, there are limitations
to it. Break-even analysis assumes that the fixed and variable costs remain
constant over time. In reality, this is usually not the case. Costs may change due
to factors such as inflation, changes in technology, or changes in market
conditions.
Another limitation is that Break-even analysis makes some oversimplified
assumptions about the relationships between costs, revenue, and production
levels. For example, it assumes that there is a linear relationship between costs
and production. This is not always true. Also, break-even analysis ignores external
factors such as competition, market demand, and changing consumer
preferences, which can have a significant impact on a businesses' top line.

Why is Break-Even Analysis Important to Stock and

Option Traders?
Stock and option traders need break-even analysis to facilitate several
functions. Firstly, they use break-even analysis to help them figure out at which
point their stock and option positions become profitable. Also, break-even
analysis help stock and option traders manage their risks. Through knowing
their break-even value, stock and option traders can set stop loss levels that
mitigate their losses if the trade moves against them.
Another reason why break-even analysis is important to stock and option
traders is that break-even analysis provides insight into their positions'
profitability. By determining the breakeven point for their positions, stock and
option traders can gauge the potential risk-reward ratio and make informed
decisions as to whether to pursue a stock or option trade.
What Are the Components of Break-Even Analysis?
There are five components of Break Even Analysis. They are: fixed costs,
variable costs, revenue, the contribution margin and the break-even point. Fixed
costs entails expenses that do not vary with changes in the level of production
or sales. However, variable costs do change with the level of production or sales.
Revenue represents total income generated from the sale of goods or services
by an individual or business. The contribution margin is the difference between
revenue and variable costs. The final component of break-even analysis, the
break-even point, is

the level of sales where total revenue equals total costs. At this point no profit is
made and no loss is incurred.
Why Is the Contribution Margin Important in Break-
Even Analysis?
The contribution margin's importance lies in the fact that it represents the
amount of revenue required to cover a business' fixed costs and contribute to
its profit. Through the contribution margin calculation, a business can determine
the break-even point and where it can begin earning a profit.
Also, by understanding the contribution margin, businesses can make informed
decisions about the pricing of their products and their levels of production.
Businesses can even develop cost management strategies to improve
efficiencies.
How Do Businesses Use the Break-Even Point in Break-
Even Analysis?
The break-even point component in break-even analysis is utilized by
businesses in various ways. The break-even point helps businesses with pricing
decisions, sales forecasting, cost management and growth strategies. With the
break-even point, businesses can figure out the minimum price they need to
charge to cover their costs. When this point is measured against the market
price, businesses can improve their pricing strategies.
The Bottom Line
Break-even analysis is a financial tool that is widely used by businesses as well
as stock and option traders. For businesses, break-even analysis is essential in
determining the minimum sales volume required to cover total costs and break even. It
helps businesses make informed decisions about pricing strategies, cost
management, and operations.
In stock and option trading, break-even analysis is important in determining the
minimum price movements required to cover trading costs and make a profit.
Traders can use break-even analysis to set realistic profit targets, manage risk,
and make informed trading decisions. It is an essential tool for investors and
financial analysts in determining the financial performance of companies and
making informed decisions about investments. By understanding the break-even
point, investors can make profitable investment decisions and manage risks
effectively. Overall, break-even analysis is a critical tool in the financial world for
businesses, stock and option traders, investors, financial analysts and even
government agencies.