BREAK EVEN ANALYSIS BREAK EVEN ANALYSIS
- 2. BREAKEVEN ANALYSIS • Also known as Cost-Volume –Profit Analysis OR Marginal costing • It is the analysis of three variables viz. Cost, Volume and Profit • This analysis explores the relationship existing amongst cost,revenue,activity level and resulting profit • Helpful in predicting how the changes in costs and sales volume influence profit
- 3. BREAK EVEN ANALYSIS an overview In a narrow sense “It refers to a system of analysis which determines the levels of Operations/production required for an enterprise so that it neither earns profit nor suffers from a loss” In a broad sense “ It refers to a system of analysis that can be used to determine the probable profit at any level of activity”
- 4. Types of costs involved 1. Fixed cost Cost which does not vary with the level of the activity or no. of units produced Eg: Executive salaries, Rent, insurance etc.
- 5. 2. Variable cost Cost which varies in direct proportion with the level of the activity or the no.of units produced Eg: Cost of material , packaging cost, sales commission etc.
- 6. 3. Semi variable cost It is a combination of fixed and variable costs Partly affected by the variation in the level of the activity Will not vary in the same proportion of the activity level It differs at different levels of the activity Eg: Telephone bill,cost of gas,electricity etc.
- 7. Semi Variable Cost ** Not necessary that it increases in step manner ** It can also be a curve sometimes
- 8. Semi variable costs • It has two components – Fixed component – Variable component C V P Analysis takes into account The Total cost (fixed and variable) Total revenue Desired profits with the sales volume Fixed component of Semi Variable cost will be added to fixed cost and Variable component will be added to Variable cost
- 9. Assumptions made in Break even Analysis • Volume is the only cost driver • Expenses can be classified as fixed and variale • CVP relations are linear over a wide range of production and sales • Unit sales price, unit Variable cost and the total fixed expenses will not vary with in the relevant range
- 10. Assumptions contd… • The relevant range of volume is specified • There is a proper synchronisation between the production and the sales.This assumes that the everything produced is sold and there is no change in the inventory level • The firm deals with only one product or the sales mix remains unchanged
- 11. Break even chart 800 200 50000 400 1000 580 150000 100000 200000 Output/ Sales volume Cost and Sales Revenue (Rs.) Fixed cost Break even point
- 12. BEP “ Break even point is the level of activity( Sales volume) where total revenue and total expenses are equal” It is the output or the level of the activity where the enterprise neither earns profit nor incur any loss It shows the minimum operating level below which it is dangerous to fall
- 13. Important terms in BEP analysis • Contribution /Contribution margin = Total revenue – Total Variable cost or Total sales – Total Variable cost It is the tool which shows the income available from the sale process to pay the fixed cost Once the fixed cost is paid the result will be profit
- 14. • The contribution can also be defined as “ a measure of economic value that tells how much the sale of one unit of the product will contribute to cover the fixed costs, with the remainder going to result in profit” • i.e. Contribution/ unit = (selling price/unit ) – (Variable cost/unit)
- 15. Contribution Ratio • Contribution ratio = • It is used for comparing the profitability of several products with in a production line and the profitable products can be identified • Any change in the contribution will have complete impact on profit
- 16. 800 200 50000 400 1000 580 150000 100000 200000 Output/ Sales volume Cost and Sales Revenue (Rs.) Fixed cost Break even point Contribution
- 17. • Profit = Sales – Total cost i.e = Sales – ( Total variable cost – total fixed cost)
- 18. • Sales ------- xxxxx − Variable cost ------- xx Contribution ------- xxxxx − Fixed cost ------- xx PROFIT ------- xxxx
- 19. Profit = ( S –V)Q –F.C S = selling price/ unit V = Variable cost/unit Q = No of units to be sold to attain the desired profit Therefore Q=
- 20. Example :1 • A company wants to produce a new mountain bike called YAMAHA elevator and has forecast the following information – Price/ bike ------ Rs. 1,25000 – Variable cost / Bike ----- Rs. 45,000 – Fixed cost related to production ---- Rs.50,000000 – Targeted profit = Rs. 10,0000000 – Estimated sales = 1500 bikes Determine the no.of bikes needed for the targeted profit
- 21. Example 1 • Solution No of bikes to be sold (Q) = = 1875 bikes
- 22. Profit volume (P/V) Ratio or CONTRIBUTION MARGIN RATIO • It is the ratio of contribution to sales revenue or turn over • P/v ratio = OR
- 23. Other equations for p/v ratio P/v = P/v = P/v =
- 24. Other equations for p/v ratio P/V = ∵ Contribution- Fixed cost = Profit P/v ratio can be considered as the % by which the revenue exceeds the variable cost
- 25. Example 2 • A company wants to produce induction motors and has the following forecast informations available • Price/ motor ---------- Rs.800 • Variable cost ---------- Rs. 300 • Fixed cost ---------- Rs.55,00,000 • Targeted profit ---------- Rs.2,00,000 • Estimated sales ---------- 12,000 Check the P/V ratio
- 26. Solution Ex:2 Total revenue = 800 x 12,000 = Rs.96,00,000 Total variable cost = 300 x 12,000 = Rs. 36,00,000 Contribution = Revenue – V.C = Rs. 96,00,000 – Rs. 36,00,000 = Rs. 6,000,000
- 27. Ex:2 Soln. • P/V Ratio = = .625 = 62.5% i.e it is giving a margin of 62.5% of the sales More the value of P/v Ratio more will be the profit
- 28. Uses of P/V ratio • To Determine of B E P • To know profit for given sales • To know the sales volume for achieving desired profit P/v ratio can be increased by Increasing the selling price Changing the mix of the sales Reducing the variable cost
- 29. EQUATIONS TO FIND BEP • @ BEP (Sales price/unit ) X Output(Q) = (Variable cost/unit) X Q + Fixed cost ∴ Fixed cost (F.C) = ( S.Pper unit – V.C Per unit) Q ∴ BEP (Q) In terms of units = i.e. =
- 30. BEP in terms of Sales Revenue • BEP = X Unit selling price i.e. =
- 31. Equations to find BEP • If a banker provides term loan to the industrial unit,from the banker’s point of view BEP =
- 32. Target sales volume • Target sales volume=
- 33. Example:3 • Sales 5000 • Sales Price/ unit =Rs.50 • VC/ unit = Rs.30 • Fixed cost = Rs.35,000 • How many units have to be sold to cover up Fixed cost as selling one unit gives a margin of 20?
- 34. Example 3 soln. • @BEP • FC = Contribution/ unit X Break even output (Q) ∴ BEP (Q) IN UNITS = FC/ CM = 35,000/ 20 = 1750 Units BEP in terms of sales = 1750 x unit selling price = 1750 X 50 = Rs.87,500
- 36. MARGIN OF SAFETY Margin of safety = Actual sales – Sales at the Break Even Point i.e. 40000- 25000 = 15,000 units
- 37. Margin of safety in terms of sales revenue M O S = Target Revenue – Break even revenue
- 38. MOS as % • Margin of safety (%) = X 100% X100%
- 39. Margin of safety What is it’s importance? It represents “ By How much amount the actual or budgeted sales should be greater than the BEP sales so that the company won’t land up in losses incase due to recession or lower sales” It shows “ if the sales falls, how much it can fall down before the enterprise start incurring losses”
- 40. Margin of safety What is it’s importance? MOS is very much useful for enterprise if it wants to know “how much safety level it has?” to defend recession or the fall in sales volume MOS represents the strength of the business
- 41. Example 4 Refer the example 3 and find out the MOS MARGIN OF SAFETY = Actual sales – BEP Sales Actual sales = x100% = 65% Even if the sales (5000) decreases by 65% the business won’t face any losses
- 42. • Profit can be determined directly w.r.to margin of safety and P/V ratio • i.e. Profit=(MOS)in units X Contribution margin/unit
- 43. • Safety margin( Amount) can also be found out as OR
- 44. EFFECT OF INCREASE IN FIXED COST ON BEP
- 45. EFFECT OF INCREASE IN VARIABLE COST ON BEP
- 46. EFFECT OF INCREASE IN SALES PRICE ON BEP
- 47. • BEP IS USEFUL 1. To find a suitable product mix 2. To find out the sales required to reach a desired revenue 3. To find out the profits at certain price levels and sales 4.