Assumption for Break Even Analysis: Assumption for Break Even Analysis The relation between total cost and level of out put is linear. The fixed cost is remain constant The price of raw material labor etc. are assumed to be constant what ever is produced is sold out immediately
Break Even Analysis: Break Even Analysis An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even analysis calculates margin of safety, the amount that revenues exceed the break-even point.
Break Even Analysis: kiet 3 Break Even Analysis Collect financial and cost information to determine fixed and variable costs Fixed costs Variable cost/unit (labor, materials, overhead) Estimate Selling Price per unit from marketing analysis and market testing Determine BE volume and compare to estimated sales If estimated sales volume is not above the BE volume, make adjustments
Types of Cost : kiet 4 Types of Cost Fixed costs - do not vary (e.g., lease costs, rent, insurance) Variable costs - vary with volume of production (e.g., labor, materials, supplies, rent, etc.) Overhead can also be applied here as a variable expense or burden rate . Selling cost : this is the price at which the one unit of product is to be sell out.
Fixed Cost Fixed cost is the the same, regardless of volume: kiet 5 Fixed Cost Fixed cost is the the same, regardless of volume
Variable Cost + Fixed Cost Total Cost goes up with volume because Variable Cost increases: kiet 6 Variable Cost + Fixed Cost Total Cost goes up with volume because Variable Cost increases
Total Revenue is based on volume and selling price/unit. Where the Revenue and Total Cost lines intersect is the Break Even (BE) Point. That volume is the BE Volume: kiet 7 Total Revenue is based on volume and selling price/unit. Where the Revenue and Total Cost lines intersect is the Break Even (BE) Point. That volume is the BE Volume
Profit Above the BE point, the difference between the Revenue and Total Cost lines represents profit: kiet 8 Profit Above the BE point, the difference between the Revenue and Total Cost lines represents profit
Loss If volume is below the BE point, the difference between the lines represents a loss: kiet 9 Loss If volume is below the BE point, the difference between the lines represents a loss
Breakeven Volume: kiet 10 Breakeven Volume Profit Equation - Profit = Revenue - Expenses Total Variable Cost (VC) is a function of volume (x) of units sold. Total VC = (Variable Cost/unit) * x Total Cost = Fixed Cost + Total VC Revenue is also a function of units sold: Revenue = (Price/unit) * x Breakeven Volume is the number of units you need to sell so that: Revenue = Total Cost
Breakeven Volume (cont’d): kiet 11 Breakeven Volume (cont’d) Find x such that: (Price/unit) * x = Fixed + (VC/unit) * x Therefore: x BE = Fixed Cost / (Price/unit) –(VC/unit) If actual volume is < x BE , you have a loss If actual volume is > x BE , you have a profit
Important terms: Important terms Angle of incidence: this is the angle at which sales revenue line cuts the total cost line. Large angle shows profit at high rate Margin of safety: it is excess of budgeted or actual sales over the break even sales volume. Margin of safety= Budgeted sales-sales at B.E.P. It is generally expressed as ratio of actual sales to sales at B.E.P. % of difference between actual sales and BEP sales to budgeted sales. profit=margin of safety- variable cost. Profit –volume (P/V) Ratio: It is the ratio of contribution (total sales-variable cost)to the sales . It indicate relation between contribution and turnover. 12