INTRODUCTION

 A breakeven analysis is used to determine how much sales

volume your business needs to start making a profit.

 The breakeven analysis is especially useful when you're

developing a pricing strategy, either as part of a marketing
plan or a business plan.

 In economics & 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".

 Total cost = Total revenue = B.E.P.

BREAK EVEN POINT
 BREAK EVEN ANALYSIS
In order to calculate how profitable a product will be, we must
firstly look at the Costs Price and Revenue involved.
 There are two basic types of costs a company incurs.
•Variable Costs
•Fixed Costs

 Variable costs are costs that change with changes in

production levels or sales. Examples include: Costs of
materials used in the production of the goods.

 Fixed costs remain roughly the same regardless of

sales/output levels. Examples include: Rent, Insurance
and Wages
 Unit Price:
The amount of money charged to the customer for each unit of a
product or service.

 Total Cost:
The sum of the fixed cost and total variable cost for any given level of
production.
(Fixed Cost + Total Variable Cost )

 Total Variable Cost:

The product of expected unit sales and variable unit cost.
(Expected Unit Sales * Variable Unit Cost )
 Total Revenue:
The product of expected unit sales and unit price.
(Expected Unit Sales * Unit Price )

 Profit/ loss
The monetary gain or loss resulting from revenues after
subtracting all associated costs. (Total Revenue - Total
Costs)
 ASSUMPTIONS
 All elements of cost i.e. production, administration and selling
distribution can be divided into fixed and variable components.

 Variable costs remain constant per unit of output.

 Fixed cost remain constant at all volume of output.

 Selling price per unit remains unchanged or constant at all levels

of output.

 Volume of production is the only factor that influences cost.

 There will be no change in the general price level.

 There is one product and in case of multi product, the sales

remain constant.
 COMPUTATION
 The break-even point (in terms of Unit Sales (X)) can be directly
computed in terms of Total Revenue (TR) and Total Costs (TC) as:

where:
TFC is Total Fixed Costs, P is Unit Sale Price, and V is Unit Variable Cost

The quantity (P – V) is of interest in its own right, and is called

the Unit Contribution Margin (C): it is the marginal profit per unit,
or alternatively the portion of each sale that contributes to Fixed
Costs
EXAMPLES
 For example, suppose that your fixed costs for producing
100,000 product were 30,000 Rs a year.

 Your variable costs are 2.20 R.s materials, 4.00 R.s labor, and
0.80 Rs overhead, for a total of 7.00 R.s per unit.

 If you choose a selling price of 12.00 Rs for each product, then:

 BEP= TFC/P-V

 30,000(TFC) divided by [12.00(P) - 7.00(V)] 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.
EXAMPLE
 For example, if it costs R.s. 50 to produce a pen, and there
are fixed costs of R.s.1,000, the break-even point for selling
the widgets would be:

If selling for R.s. 100: 20 Widgets

(Calculated as 1000/(100-50)=20)

If selling for $200: 20 Widgets (Calculated as 1000/(200-

50)=6.7)

From this we can make out that the company should sell
products at higher price to reach BEP faster.
 The
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 If the firm
chose to set
Break-Even Analysis price higher
than Rs.2
Costs/Revenue TR (p = Rs.3) (say Rs.3) the
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VC TR curve
would be
steeper – they
would not
have to sell as
many units to
break even

FC

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 Break-Even Analysis
TR (p = Rs.1)
Costs/Revenue If the firm
TR (p = Rs.2)
TC chose to set
VC
prices lower
(say Rs.1) it
would need
to sell more
units before
covering its
costs

FC

Q1 Q3 Output/Sales
 Break-Even Analysis
TR (p = Rs.2)
Costs/Revenue TC
Profit VC

Loss
FC

Q1 Output/Sales
 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) OR

 Margin o safety = actual sales – BEP sales

 margin of safety% = (current output - breakeven

output)/current output × 100
Break-Even Analysis Margin of
safety shows
how far sales
can fall before
TR (p = Rs. 3) TR (p = Rs. 2)
TC losses made. If
Costs/Revenue
Q1 = 1000 and
VC Q2 = 1800, sales
could fall by 800
units before a
loss would be
made
ales
A higher
price
would
Margin of Safety lower the
break
FC even
point and
the
Q3 Q1 Q2 margin of
Output/S
safety
would
widen
 USES OF BREAK EVEVN POINT
 Helpful in deciding the minimum quantity of sales

 Helpful in the determination of tender price.

 Helpful in examining effects upon organization’s

profitability.

 Helpful in deciding about the substitution of new plants.

 Helpful in sales price and quantity.

 Helpful in determining marginal cost.

 LIMITATIONS
 Break-even analysis is only a supply side (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

 It assumes average variable costs are constant per unit of output,

at least in the range of likely quantities of sales.

 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.

 In multi-product companies, it assumes that the relative

proportions of each product sold and produced are constant.
CONCLUSION
 A company should determine its break even point before
selling its products.

 In order to know how price your product, you first have

to know how to calculate breakeven point.

 Break-even analysis is a supply side analysis; that is it only

analyzes the costs of the sales.

 It does not analyze how demand may be affected at different

price levels.