BREAK- EVEN

In economics and business, specifically cost accounting, the break-even point (BEP) is the
point at which cost or expenses and revenue are equal: there is no net loss or gain, and one
has "broken even." A profit or loss has not been made, although opportunity costs have been
"paid" and capital has received the risk- ...

Break-even analysis is a method that is used by most of organizations to determine, a

relationship between costs, revenue, and their profits at different levels of output'. It helps in
determining the point of production at which revenue equals the costs.

A break-even analysis is a financial tool which helps you to determine at what stage your
company, or a new service or a product, will be profitable. In other words, it's a financial
calculation for determining the number of products or services a company should sell to
cover its costs (particularly fixed costs).

Formula for Break Even Analysis

The formula for break even analysis is as follows:

Break even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)
Where:

 Fixed costs are costs that do not change with varying output (i.e. salary, rent, building
machinery).
 Sales price per unit is the selling price (unit selling price) per unit.
 Variable cost per unit is the variable costs incurred to create a unit.

It is also helpful to note that sales price per unit minus variable cost per unit is the
contribution margin per unit. For example, if a book’s selling price is $100 and its variable
costs are $5 to make the book, $95 is the contribution margin per unit and contributes to
offsetting the fixed costs.

Example of Break Even Analysis

Colin is the managerial accountant in charge of Company A, which sells water bottles. He
previously determined that the fixed costs of Company A consist of property taxes, a lease,
and executive salaries, which add up to $100,000. The variable costs associated with
producing one water bottle is $2 per unit. The water bottle is sold at a premium price of
$12. To determine the break- even point of Company A’s premium water bottle:

Break even quantity = $100,000 / ($12 – $2) = 10,000

Therefore, given the fixed costs, variable costs, and selling price of the water bottles,
Company A would need to sell 10,000 units of water bottles to break even.

Cash flow balance

A cash flow statement is a financial statement that summarizes the amount of cash and cash
equivalents entering and leaving a company. The cash flow statement measures how well a
company manages its cash position, meaning how well the company generates cash to pay its
debt obligations and fund its operating expenses.

Additions to property, plant, equipment, capitalized software expense, cash paid in mergers
and acquisitions, purchase of marketable securities, and proceeds from the sale of assets are
all examples of entries that should be included in the cash flow from investing activities
section.

How Do the Balance Sheet and Cash Flow Statement Differ?

Two Legs of the Financial Statement Stool

The balance sheet and cash flow statement are two of the three financial statements that
companies issue to report their financial performance. The financial statements are used by
investors, market analysts, and creditors, to evaluate a company's financial health and
earnings potential.
Balance Sheet

A balance sheet lists a company's assets, liabilities, and shareholders' equity for a period. A
balance sheet shows what a company owns in the form of assets, what it owes in the form of
liabilities, and the amount of money invested by shareholders listed under shareholders'
equity.

The balance sheet shows a company's assets, but also shows how those assets were
financed, whether it was through debt or through issuing equity. The balance sheet is broken
down into three parts: assets, liabilities, and owners' equity, and it is represented by the
following equation:

Assets=Liabilities+Owners’ Equity

Where: Owners’ Equity=Total Assets minus total liabilities

The equation above must always be in balance. If cash is used to pay down a company's debt,
for example, the debt liability account is reduced, and the cash asset account is reduced by the
same amount, keeping the balance sheet even. The name "balance sheet" is derived from the
way that the three major accounts eventually balance out and equal each other; all assets are
listed in one section, and their sum must equal the sum of all liabilities and the shareholders'
equity.

Below are examples of items listed on the balance sheet:

Assets

 Cash and cash equivalents are liquid assets, which may include Treasury
bills and certificates of deposit.
 Marketable securities are equity and debt securities.
 Accounts receivables are the amount of money owed to the company by its customers
for product and service sales.
 Inventory is either finished goods or raw materials.

Liabilities

 Debt including long-term debt

 Rent, tax, utilities
 Wages payable
 Dividends payable

Shareholders' Equity

 Shareholders' equity is a company's total assets minus its total

liabilities. Shareholders' equity represents the net value or book value of a company. It
is the amount of money that would be returned to shareholders if all of the assets were
liquidated and all of the company's debt was paid off.
  Retained earnings are recorded under shareholders' equity and are the percentage
of net earnings that were not paid to shareholders as dividends. Instead, the money
was retained to be reinvested in the business, or pay down debt.

The Cash Flow Statement

The cash flow statement shows the amount of cash and cash equivalents entering and leaving
a company.

The cash flow statement (CFS) measures how well a company manages and generates cash to
pay its debt obligations and fund operating expenses. The cash flow statement is derived from
the income statement by taking net income and deducting or adding the cash from the
company's activities shown below.

The three sections of the cash flow statement are:

 Cash from operating activities

 Cash from investing activities
 Cash from financing activities

Operating activities on the CFS include any sources and uses of cash from business
activities. In other words, it reflects how much cash is generated from the sale of a company's
products or services.

Changes made in cash, accounts receivable, inventory, and accounts payable are shown in
cash from operating activities and might include:

 Receipts from sales of goods and services

 Interest payments
 Income tax payments
 Payments made to suppliers
 Salaries and wages

Investing Activities: These activities include any incoming or outgoing cash from a
company's long-term investments. Investing activities include:

 A purchase or sale of an asset

 Loans made to vendors or received from customers
 Merger or acquisition payments or credits to cash

Financing Activities: These activities include cash from investors or banks, as well as the
use of cash to pay shareholders. Financing activities include:

 Payment of dividends
 Payments for stock repurchases
 Repayment of debt principal (loans)

A balance sheet is a summary of the financial balances of a company, while a cash flow
statement shows how the changes in the balance sheet accounts and income on the income
statement affect a company's cash position. In essence, a company's cash flow statement
measures the flow of cash in and out of a business, while a company's balance sheet measures
its assets, liabilities, and owners' equity.

Depreciation

Depreciation is a non-cash expense that reduces the value of an asset as a result of wear and
tear, age, or obsolescence over the period of its useful life.

What Are the Main Types of Depreciation Methods?

There are several types of depreciation expense and different formulas for determining the
book value of an asset. The most common depreciation methods include:

1. Straight-line
2. Double declining balance
3. Units of production
4. Sum of years digits

Depreciation expense is used in accounting to allocate the cost of a tangible asset over its
useful life. In other words, it is the reduction in the value of an asset that occurs over time due
to usage, wear and tear, or obsolescence. The four main depreciation methods mentioned
above are explained in detail below.

1 Straight-Line Depreciation Method

Straight-line depreciation is a very common, and the simplest, method of calculating
depreciation expense. In straight-line depreciation, the expense amount is the same every year
over the useful life of the asset.

Depreciation Formula for the Straight Line Method:

Depreciation Expense = (Cost – Salvage value) / Useful life

Example

Consider a piece of equipment that costs $25,000 with an estimated useful life of 8 years and
a $0 salvage value. The depreciation expense per year for this equipment would be as
follows:

Depreciation Expense = ($25,000 – $0) / 8 = $3,125 per year

Replacement Analysis of Equipment’s

Introduction to Equipment Replacement Analysis:

Equipment replacement decision plays an important role in the economic running of any
concern for years or decades.
A firm has to face three types of replacement decisions:

(a) The replacement of capital equipment, as it wears out or becomes obsolete.

(b) The capital equipment required for expansion.

(c) The displacement of old technology by the new, i.e. the introduction of an improved
equipment in the market which may produce cheaper products. It is also known as
replacement of obsolete equipments.

Equipments are used to produce products at profitable rate, so that the products can stand
competition. Replacement decision is not an easy job, it requires several considerations. As it
involves large capital investment, hence a wrong decision may adversely effect the
profitability of whole concern. Therefore, a scientific approach to solve such problems is
essential.

Reasons for Replacement of Equipment:

The main reasons are:

(a) Deterioration,

(b) Obsolescence,

(c) Inadequacy, and

(d) Working conditions.

(а) Deterioration:

It becomes necessary to replace the machine when it wears out and does not function
properly. Such machinery start lowering the quality of product, decreasing the production and
increase in labour and maintenance costs.

b) Obsolescence:

Whenever new equipment comes in the market, which is capable of producing more products
of good quality with less labour and has more efficiency, the existing machine is to be
replaced with this machine, although it was functioning well.

Generally this is necessitated because the products manufactured by new machine will be
cheaper.

(c) Inadequacy:

With the change of product design to meet the customers demand or quantity to be
manufactured, old machinery becomes inadequate and, therefore, calls for different
manufacturing equipment.

(d) Working Conditions:

To take replacement decision, working conditions are also responsible. Machinery yielding
more smoke or noise (unpleasant conditions) and hazardous to work may cause pollution and
accidents. Similarly, worker may not like to work on an old machinery because of hazardous
nature of a particular process. Such machinery needs replacement.

Inflation

Inflation is an economic term that refers to an environment of generally rising prices of

goods and services within a particular economy. ... For example, prices for many consumer
goods are double that of 20 years ago.

Inflation reduces the purchasing power of each unit of currency, which leads to increases in
the prices of goods and services over time. It's an economics term that means you have to
spend more to fill your gas tank, buy a gallon of milk, or get a haircut. In other words, it
increases your cost of living.

Inflation Rate

The inflation rate is the percentage increase or decrease in prices during a specified period,
usually a month or a year. The percentage tells you how quickly prices rose during the
period. For example, if the inflation rate for a gallon of gas is 2% per year, then gas prices
will be 2% higher next year.

Causes

There are two causes of inflation. The most common is demand-pull inflation. That's when
demand outpaces supply for goods or services. Buyers want the product so much that they're
willing to pay higher prices.

Cost-push inflation is the second, less common, cause. That's when supply is restricted but
demand is not. That happened after Hurricane Katrina damaged gas supply lines. Demand for
gasoline didn't change, but supply constraints raised prices to $5 a gallon.

Some sources say that an increase in the money supply also causes inflation.that’s a
misinterpretation of the theory of monetarism. It says the primary cause of inflation is the
printing out of too much money by the government. As a result, too much capital chases too
few goods. It creates inflation by triggering either demand-pull or cost-push inflation.

Some also count built-in inflation as a third cause.3This factors people’s expectations of
future inflation. When prices rise, labor expects an increase in wages to keep up. But higher
wages raises the cost of production, which raises prices of goods and services again. When
this cause-and-effect continues, it becomes a wage-price spiral.