Wednesday, September 16, 2009

BREAK EVEN ANALYSIS


B R E A K- E V E N A N A L Y S I S
1. What is?
Profit maximization the ultimate objective of all business concerns. Profit is the resultant of the interplay of costs, price and volume.
v By a study of break-even-analysis, the managements knows how much sales, both in units and in value should be effected to avoid loss at the least.
v Cost-Volume-profit analysis (known otherwise) is an attempt at systematic study of the relationship existing among these variable factors and it analysis the effect of a change or changes in these factors on profits.
v It is an integral part of profit planning.
2. Breakeven Point (BEP)
v Total costs incurred total value of sales made = No loss or profit
i.e. Sale proceeds = Total costs (Fixed & variable = BEP
If sales go up beyond BEP = Profit
If sales come down = Loss
v A sale at Break-even point is the minimum amount of sales to be effected to avoid loss.
v BEP is an extension of the principles of marginal costing
v Break-even chart is a primary form of profit graph, which is a useful device to the management to inform the effects of changes in costs, volume and revenue.
Let us now construct a break-even chart on the basis of the following information (illustrativey)
Selling price - Re.0.40 per unit
Variable cost - Re.0.20 per unit
Fixed costs - Rs.2, 000
(Maximum)
From these data we can derive the following table to construct the chart
v The excess of actual sales over the break-even sales is the margin of safety
v Higher the margin of safety more will be the profits for the organization, because only after reaching the BEP, sales bring forth profits.
v This concept is useful in times of depression when the sales are gradually declining
v M-S = Actual sales – Break-even sales x 100
Actual sales
4. Angle of incidence (Profit angle or profit path)
v It indicates rate at which profit is earned in an organization after crossing the BEP.
v A wide angle represents a higher rate of profit earning and a narrow angle implies relatively a low rate of return.
v The consideration of the angle of incidence arises only after meeting the entire amount of fixed costs. Therefore the nature of angle depends upon the incidence of variable costs.
v A narrow angle indicates that variable costs form relatively a large part of the cost of the product and vice-versa
5. Profit-Volume-Ratio (P.V.R.)
v It indicates the relation between the sales value and its corresponding contribution.
v It explains the rate at which sales are contributing towards the recovery of fixed costs and profits.
v A high ratio means that the BEP is achieved sooner after which profit is earned at a higher rate and a low ratio implies the opposite.
v PVR = Sales – Variable costs (i.e. contribution) x 100
Sales
(Profit here means contribution)

Formulae:

v
P.V.R. = S-V x 100 S Where S = Sales Value V = Variable cost S-V = C (Contribution)
M.S. = P/PVR Where P = Profit

Volume of Sales = F+P / PVR Where F = Fixed Costs P= Profit
BEP (In value) = F/ PVR Where F = Fixed costs
BEP (In Units) =F/P-V Where F = Fixed costs P = Price V = Variable costs
Illustration:
The accountant of ABC Company Ltd. provides the following data for the year 1978:
Sales 15,000 units @ Rs.4 per unit = Rs.60, 000
Variable cost @ Rs.2 per unit = Rs.30, 000 (50%)
-------------
Contribution = Rs.30, 000
Less Fixed Costs = Rs.18, 000
-------------
Profit = Rs.12, 000
------------
You are required to find out the following:
a) Profit = Volume Ratio
b) Break-even Point and
c) Margin of safety

Workings:
a) Profit – Volu me Ratio = S – V x 100
S
P.V.R. = 60,000 - 30,000 x 100 = 50%
60,000
b) Break-even Point = Fixed costs
P/V Ratio
= 18,000 = 18,000 x 100 = Rs.36000
50% 50
c) Margin of Safety = Profit
P/V Ratio
Ms = 12,000 = 12000 x 100 = Rs.24000
50% 50
The results can be verified as follows:
Break-even Point Sales = Rs.36, 000
At this level the total costs are –
Fixed costs = Rs, 18,000
Variable costs = Rs.18, 000 (50% of sales)
------------
Total cost = Rs.36, 000
------------
Margin of Safety = Rs.24, 000
Sales beyond break-even point constitute the Margin:
.
. . Ms = Actual sales – BEP
= 60,000 – 36,000
= Rs.24, 000


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