Break-even Analysis
Break-even analysis is a technique widely used by production management and management
accountants. It is based on categorizing production costs between those which are "variable"
(costs that change when the production output changes) and those that are "fixed" (costs not
directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the level of
sales volume, sales value or production at which the business makes neither a profit nor a
loss (the "break-even point").
Break-even point:
The break-even point for a product is the point where total revenue received equals the
total costs associated with the sale of the product (TR=TC). A break-even point is typically
calculated in order for businesses to determine if it would be profitable to sell a proposed
product, as opposed to attempting to modify an existing product instead so it can b e made
lucrative.
BREAK EVEN ANALYSIS
ASSUMPTIONS
1. All costs are either perfectly variable or absolutely fixed over the entire period of production
but this assumption does not hold good.
2 .The volume of production and the volume of sales are equal; in reality it differs.
3. The revenue is perfectly variable with physical volume of production and this assumption is
not valid.
4. The assumption of stable product mix is unrealistic.
METHODS
The break-even point can be computed by the following methods:
1. Algebraic Method
2. Break even Chart
1. ALGEBRAIC METHOD
Total revenue is equal to the selling price (P) per unit times the quantity of output or sales(Q) .
That is
TR = (P) * (Q)
Total costs equal total fixed costs plus total variable costs (TVC). Since TVC is equal to the
average variable cost (AVC) times the quantity of output or sales, we have
TC =TFC + TVC
Or TC =TFC +(AVC) * (Q)
Setting total revenue equal to total costs and substituting QB (the break even output) for Q, we
have
TR = TC
P * QB = TFC + AVC * QB
Or, TFC = P * QB – AVC * QB
QB = TFC / (P - AVC)
The denominator in the above equation (i.e., P – AVC) is called Contribution margin per unit
because it presents the portion of the selling price that can be applied to cover the fixed costs, of
the firm and to the firm and to provide for profits.
a) Contribution Margin :
BEP (In units) = (total fixed cost) / Contribution per Unit
BEP (In Rs.) = (Total Fixed cost * Sales ) / Contribution
Contribution = Sales – Variable Cost
P/V Ratio = (Contribution / Sales) * 100
Or
P/V Ratio = (Change in profits / Change in sales) * 100
b) Equation Technique :
Selling Price = Fixed Cost + Variable Cost( No of units sold to Break-even) + Net
Income
2. BREAK EVEN CHART/ GRAPHIC METHOD OF BREAK-EVEN ANALYSIS:
In its simplest form, the break-even chart is a graphical representation of costs at various levels
of activity shown on the same chart as the variation of income (or sales, revenue) with the same
variation in activity.
The point at which neither profit nor loss is made is known as the "break-even point" and is
represented on the chart below by the intersection of the two lines:
In the figure total revenues and total costs are plotted on the vertical axis whereas output or sales
per time period are plotted on the horizontal axis. The slope of TR curve refers to the constant
price at which the firm can sell its output. The TC curve indicates total fixed costs (TFC) and a
constant average variable cost. This is often the case for many firms for small changes of output
or sales. The firm breaks even at TR = TC, Q. and incurs losses at smaller outputs while earns
profits at higher levels of output.
Both the total cost and total revenue curves are shown as linear. TR curve is linear as it is
assumed that the price given, irrespective of the output level. Linearity of TC curve results from
the assumption of constant variable costs.
The safety margin
The excess of budgeted volume over the break-even volume is generally known as the mar gin of
safety. It reveals the amount by which sales may decline before losses occur. The concept may
be expressed as a percentage through driving the Sales Margin of safety by sales.
Safety margin = (Sales break – even point ) * 1000
The margin s validity depends upon of safety is an approximation, as its validity depends upon
the accuracy of the cost estimates at the break –even point. It tells the management either to
reduce fixed costs or to stimulate the volume of sales.
Above the breakeven point, every additional unit sold increases profit by the amount of the unit
contribution margin, which is defined as the amount each unit contributes to covering fixed costs
and increasing profits. It is defined as:
Contribution Margin = Unit Price - Unit Variable Expense
POTTI SRIRAMULU CHALAVADI MALLIKARJUNA RAO
COLLEGE OF ENGINEERING & TECHNOLOGY
Department of Management Studies
Topic : Methods Of Break-Even Analysis
Subject : Cost and Management Accounting
Submitted To : Asst.Prof. Ms. Y. Sridevi
Submitted By : K. Jai Kishan
Roll no : 09KT1E0015
