Break-even analysis is of vital importance in determining the practical application of cost functions. It is a function of three factors, i.e. sales volume, cost and profit. It aims at classifying the dynamic relationship existing between total cost and sale volume
Break-even analysis is of vital importance in determining the practical application of cost functions. It is a function of three factors, i.e. sales volume, cost and profit. It aims at classifying the dynamic relationship existing between total cost and sale volume of a company.
Hence it is also known as “cost-volume-profit analysis”. It helps to know the operating condition that exists when a company ‘breaks-even’, that is when sales reach a point equal to all expenses incurred in attaining that level of sales. The break-even point may be defined as that level of sales in which total revenues equal total costs and net income is equal to zero. This is also known as no-profit no-loss point. This concept has been proved highly useful to the company executives in profit forecasting and planning and also in examining the effect of alternative business management decisions.
1. Break-Even Point
2. Determination of Break-even Point
3. Managerial Uses of Break-Even Analysis
1. Break-Even Point:
The break-even point (B.E.P.) of a firm can be found out in two ways. It may be determined in terms of physical units, i.e., volume of output or it may be determined in terms of money value, i.e., value of sales.
ВЕР in terms of Physical Units:
This method is convenient for a firm producing a product. The ВЕР is the number of units of a product that should be sold to earn enough revenue just to cover all the expenses of production, both fixed and variable. The firm does not earn any profit, nor does it incur any loss. It is the meeting point of total revenue and total cost curve of the firm.
The break-even point is illustrated by means of Table 1:
Table 1: Total Revenue and Total Cost and ВЕР
Output in units
Total Fixed Cost
Total Variable Cost
Some assumptions are made in illustrating the ВЕР. The price of the commodity is kept constant at Rs. 4 per unit, i.e., perfect competition is assumed. Therefore, the total revenue is increasing proportionately to the output. All the units of the output are sold out. The total fixed cost is kept constant at Rs. 150 at all levels of output.
The total variable cost is assumed to be increasing by a given amount throughout. From the Table we can see that when the output is zero, the firm incurs only fixed cost. When the output is 50, the total cost is Rs. 300. The total revenue is Rs. 200. The firm incurs a loss of Rs. 100.
Similarly when the output is 100 the firm incurs a loss of Rs. 50. At the level of output 150 units, the total revenue is equal to the total cost. At this level, the firm is working at a point where there is no profit or loss. From the level of output of 200, the firm is making profit
Break-Even charts are being used in recent years by the managerial economists, company executives and government agencies in order to find out the break-even point. In the break-even charts, the concepts like total fixed cost, total variable cost, and the total cost and total revenue are shown separately. The break even chart shows the extent of profit or loss to the firm at different levels of activity. The following Fig. 1 illustrates the typical break-even chart.
In this diagram output is shown on the horizontal axis and costs and revenue on vertical axis. Total revenue (TR) curve is shown as linear, as it is assumed that the price is constant, irrespective of the output. This assumption is appropriate only if the firm is operating under perfectly competitive conditions. Linearity of the total cost (TC) curve results from the assumption of constant variable cost.
It should also be noted that the TR curve is drawn as a straight line through the origin (i.e., every unit of the output contributes a constant amount to total revenue), while the TC curve is a straight line originating from the vertical axis because total cost comprises constant / fixed cost plus variable cost which rise linearly. In the figure, В is the break-even point at OQ level of output.
In the preparation of the break-even chart we have to take the following considerations:
(a) Selection of the approach
(b) Output measurement
(c) Total cost curve
(d) Total revenue curve
(e) Break-even point and
(f) Margin of safety.
2. Determination of Break-even Point:
The formula for calculating the break-even point is
ВЕР – Total Fixed Cost/Contribution Margin Per Unit
Contribution margin per unit can be found out by deducting the average variable cost from the selling price. So the formula will be
BEP = Total Fixed Cost/Selling Pr ice – AVC
Suppose the fixed cost of a factory in Rs. 10,000, the selling price is Rs. 4 and the average variable cost is Rs. 2, so the break-even point would be
ВЕР = 10,000(4-2) = 5,000 units.
It means if the company makes the sales of 5,000 units, it would make neither loss nor profit. This can be seen in the analysis.
Sales = Rs.20, 000
Cost of goods sold:
(a) Variable cost at Rs.2 = Rs. 10,000
(b) Fixed costs = Rs. 10,000
Total Cost = Rs. 20,000
Net Profit = Nil
ВЕР in term of Sales Value:
Multi-product firms are not in a position to measure the break-even point in terms of any common unit of product. They find it convenient to determine the break-even point in terms of total rupee sales. Here again the break-even point would be where the contribution margin (sales value—variable costs) would be equal to fixed costs. The contribution margin however, is expressed as a ratio to sales. The formula for calculating the break-even point is
BEP = Fixed Cost/Contribution Ratio
Contribution Ratio (CR) = Total Revenue (TR)-Total Variable Cost (TVC)/Total Revenue (TR)
For example, if TR is Rs. 600 and TVC is Rs. 450, then the contribution ratio is
CR = 600 – 450/600/600=150/ 600 = 0.25
The Contribution Ratio is 0.25
BEP = Total Fixed Cost /Contribution Ratio
= 150/0.25 = 600
The firm achieves its ВЕР when its sales 