BREAK EVEN POINT & ANALYSIS: BREAK EVEN POINT & ANALYSIS
DEFINITION: DEFINITION The break even point is the point where the gains equal the losses. The point defines when an investment will generate a positive return. The point where sales or revenues equal expenses. The point where total costs equal total revenues. There is no profit made or loss incurred at the break even point. It is the lower limit of profit when prices are set and margins are determined.
DEFINITION: DEFINITION At this point the income of the business exactly equals its expenditure. If production is enhanced beyond this level, profit shall accrue to the business and if it is decreased from this level, loss shall be suffered by the business.
FORMULA: FORMULA Break even point (of output) = (fixed cost) / (contribution per unit) Where, Contribution=selling cost-variable cost Fixed cost= Contribution- profit
FORMULA: FORMULA Break even point of Sales= 1. Fixed price x SP per unit Contribution per unit Fixed Cost x Total Sales Total Contribution
CALCULATION OF THE BREAK EVEN POINT: CALCULATION OF THE BREAK EVEN POINT VARIABLE COST- They are directly related to the volume of sales: that is these cost increase in proportion to the increase in sales and vice versa. FIXED COST - Fixed costs continue regardless of how much you can sell or not sell, and can be made up of such expenses as rent, wages, telephone account and insurance. These cost can be estimated by using last years figure as a basis, because they typically do not change. Formula= FIXED COST VARIABLE COSTS
PowerPoint Presentation: At break even point, the desired profit is zero. In case the volume of output or sales is to be computed for a desired profit, the amount of desired profit should be added to fixed cost is the formula given above. Units for a desired profit= Fixed cost+ desired profit Contribution per unit
PowerPoint Presentation: Sales for a desired profit= (Fixed cost + Desired profit) (P/V Ratio)or profit volume ratio Where as, P/V ratio= Contribution per unit Selling price per unit = Total contribution Total sales
CASH BREAK EVEN POINT: CASH BREAK EVEN POINT It is the point where cash breaks even i.e. the volume of sales where cash realization on account of sales will be sufficient to meet the immediate cash liabilities. The label of activities where the total costs under two alternatives are same While calculating this point cash fixed costs (i.e. excluding fixed share of depreciation and deferred expenses) and cash contribution (i.e. after making adjustments for variable share of depreciation etc.) are considered.
FORMULA FOR CASH BREAK EVEN POINT: FORMULA FOR CASH BREAK EVEN POINT Cash break even point (in units) = (Cash fixed cost) / (cash contribution per unit) Cash break even point (in sales Rs.) = (Cash fixed cost) / (cash contribution per unit) x selling price per unit
BREAK EVEN ANALYSIS: BREAK EVEN ANALYSIS It refers to the ascertainment of level of operations where total revenue equals to total costs. Analytical tool to determine probable level of operation. Method of studying the relationship among sales, revenue, variable cost, fixed cost to determine the level of operation at which all the costs are equal to the sales revenue and there is no profit and no loss situation. Important techniques is profit planning and managerial decision making.
DEFINATIONS USED IN BREAK EVEN POINT-: DEFINATIONS USED IN BREAK EVEN POINT- Fixed Cost: The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed. Variable Unit Cost: Costs that vary directly with the production of one additional unit. Expected Unit Sales: Number of units of the product projected to be sold over a specific period of time. Unit Price: The amount of money charged to the customer for each unit of a product or service.
ADVANTAGE : ADVANTAGE It is cheap to carry out and it can show the profits/losses at varying levels of output. It provides a simple picture of a business - a new business will often have to present a break-even analysis to its bank in order to get a loan.
LIMITATIONS: LIMITATIONS Break-even analysis is only a supply side ( i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. It assumes that fixed costs (FC) are constant It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. ( i.e. linearity) It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period). In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant ( i.e. , the sales mix is constant).
Profit Forecasting: Profit Forecasting Profit forecasting can not be done without proper profit forecasting, profit forecasting means projection of future earnings taking into consideration all the factors affecting the size of business profits, e.g., Firm’s pricing policies, costing policies, depriciation policy, and so on. Joel Dean has pointed out three approaches to profit forecasting.
1. Spot Projection: 1. Spot Projection Projecting the entire profits and loss statement for a specified future period by forecasting each element separately; forecasts are made about sales volume and prices and costs of producing the anticipated sales. Since profits are residual resulting from the forces that shape demand for the company’s products and govern the behavior of is costs.
2. Break – even Analysis: 2. Break – even Analysis Analysis identifying functional relations of both revenues and costs to output rate, with profits related to output as a residual; or alternatively, relating profits to output directly by the usual data used in break-even analysis.
3. Environmental Analysis: 3. Environmental Analysis Analysis relating the company’s profits to key variables in the economic environment, such as the general business activity and the general price level. These variables are general to the company.
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