Bea ppt


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Bea ppt

  2. 2. BREAK-EVEN ANALYSISAccording to Martz,Curry and Frank, "A break-even analysis indicates at whatlevel cost and revenue are in equilibrium.”•The BEP is that point of activity(sales volume) where total revenues and totalexpenses are equal.• Profit=0 EQUATION[Break even sales = fixed cost + variable cost]Fixed CostsCost that do not change when production or sales levels do change, such as rent,property tax, insurance, or interest expense. The fixed costs are summarized fora specific time period (generally one month).Variable Cost (Per Unit Cost)Variable costs are costs directly related to production units. Typical variablecosts include direct labor and direct materials. The variable cost times thenumber of units sold will equal the Total Variable Cost. Total Variable costs plusFixed costs make up the total cost of production.
  3. 3. Selling Price (per unit price) The price that a unit is sold for. Sales Tax is not included the selling price and sales taxes paid are not included as a cost. The Selling Price times the number of units sold equals the Total Sales.CHARACTERSTICS OF BREAK-EVENPOINT 1.It is a point where losses cease to occur while profits have not yet begun. 2. If the firm produces and sells less than what is suggested by BEP, it would incur losses, while if it sells more than level of BEP,it makes profit. 3.It indicates the minimum level of production/sales which the company has to undertake in order to be economically viable.
  4. 4. CALCULATING BREAK-EVEN POINT There are 2 approaches of calculating BEP: 1. Algebraic method 2. Graphical method ALGEBRAIC METHOD BEP can be calculated in 3 ways: A. Using Variable Cost equation Break even point is the level of sales where profits are zero. Therefore the break even point can be computed by finding that point where sales just equal the total of the variable expenses plus fixed expenses and profit is zero. Sales = Variable expenses + Fixed expenses + Profit
  5. 5. In the linear Cost-Volume-Profit analysis model, the break-even point (interms of Unit Sales (X)) can be directly computed in terms of Total Revenue(TR) and Total Costs (TC) as:TR=TCS*X=TFC+V*XS*X-V*X=TFC(S-V)*X=TFCX=TFC/(S-V)Where:TFC is Total Fixed Costs,S is Unit Sale Price, andV is Unit Variable Cost.Example: A coastal ship can carry 1,00,000 passengers per month at a fare ofRs.850.Variable cost per passenger is Rs.100 while the fixed cost areRs.75,00,000per month. Find breakeven quantity and sales volume for theship.
  6. 6. Solution: Breakeven quantity=TFC/(S-TVC)=75,00,000/(850-100)=75,00,000/750 =10,000passengersBreakeven Sales=TFC/{1-(TVC/S)}=75,00,000/{1-(100/850)}=75,00,000/0.8823 =Rs.85,00,000B. Using P/V ratioBEP= Fixed Cost/(P/V Ratio)where, P/V ratio=Fixed Costs/(P/Vratio)Contribution = Sales –variable costContribution = Profit+Fixed costsExample: If sales is Rs.2000, Variable cost is Rs.1200 and Fixed CostRs.400,thenBEP = Fixed cost/(P/V ratio)P/V ratio=(sales-Variable cost)/Sales=(2000-1200)/2000=0.4 or 40%BEP=400/.4=Rs.1000
  7. 7. C. Using contribution per unitThe Break-Even Point can alternatively be computed as the point whereContribution equals Fixed Costs.Total Contribution = Total Fixed CostUnit Contribution*Number of Units=Total Fixed CostsNumber of Units=Total Fixed Costs/Unit ContributionBreak-even(in Rs.)=( Fixed cost/contribution)*PriceExample: If the fixed cost of a company are Rs.60,000,the variable costRs.10per unit of output and the selling price is Rs.20per unit.Find BEP.Solution: BEP (in units)=Fixed Cost/Contribution per unit=60,000/(20-10)=6,000unitsIn currency units (sales proceeds) to reach break-even, one can use the abovecalculation and multiply by Price, or equivalently use the Contribution MarginRatio (Unit Contribution Margin over Price) to compute it as:Break-even(in Rs.)=( Fixed cost/contribution)*PriceFor the above example Breakeven Sales=(60,000/10)*20=Rs.1,20,000
  8. 8. GRAPHICAL METHODBEP is the point of intersection of TR and TC.Area to the left of BEP is region of loss and to the right is the region of profit.Helps the management in visualizing the profit or loss implications atdifferent level of sales.It shows the extent of profit or loss to the firm at different levels of theactivity. Output on horizontal axis and costs and revenue on vertical axis.Total Revenue (TR) curve is shown linear as price is assumed constantirrespective of the output. Total Cost (TC) is taken constant when variable cost is assumed as constant.
  9. 9. Example: Prepare Breakeven Chart forfollowing data:Output units 40 80 120 200Sale 400 800 1200 2000Fixed cost 400 400 400 400Variable cost 240 480 720 1200Total cost 640 880 1120 1600 1400 Net Profit 1200 1000 BEP cost,revenue(in Rs) 800 Variable TR cost 600 TC FC 400 Loss 200 Fixed cost 0 0 20 40 60 80 100 120 140 unit of output
  10. 10. Changes in Costs and Price and BEPWhen the variable costs or the fixed costs increases ,the BEP will shift to theright and vice versa.Similarly,rise in price shifts sales line upwards and BEPshifts to the left and vice versa. In this figure it shows that as the price and cost increases the BEPshifts from P1 to P2.
  11. 11. Concept of Contribution MarginContribution is the difference between total revenue and variable costs arising outof a business decision.BEP(in units)=Fixed Cost/Unit contribution marginBreak Even Sales in Rs = [Fixed Cost / 1 – (Variable Cost / Sales)] TotalContribution Profit=TR-TVC=Net Profit Fixed Cost.
  12. 12. MARGIN OF SAFETYMargin of safety represents the strength of the business.It enables a business to know what is the exact amount it hasgained or lost and whether they are over or below the break evenpoint.margin of safety = (current output - breakeven output)margin of safety% = {(current output-breakevenoutput)/current output}x100
  13. 13. BASIC ASSUMPTIONSThere are several assumptions that affect the applicability of break-even analysis.If these assumptions are violated, the analysis may lead to erroneous conclusions.1.It assumes that cost can be classified into fixed and variable costs,thus ignoringsemi-variable costs.2.Sale price of the product is assumed constant, thus giving linearity property tototal cost curve.3.It assumes constant rate of increase in variable cost, thereby imparting linearityto total cost curve.4.It assumes no improvement in technology and labor efficiency.5.Changes in input prices are also ruled out.6.Break-even analysis also assumes that the production and sales aresynchronized, in the sense that there is no addition or subtraction frominventory.A
  14. 14. BENEFITS/ADVANTAGES OF BREAK-EVEN ANALYSIS1.The main advantages of break even point analysis is that it explains therelationship between cost, production, volume and returns.2. It can be extended to show how changes in fixed cost, variable cost,commodity prices, revenues will effect profit levels and break even points.3.Break even analysis is most useful when used with partial budgeting, capitalbudgeting techniques.4.It indicates the lowest amount of business activity necessary to prevent losses.
  15. 15. USES OF BEP1. It helps in determining the optimal level of output, below which it would not beprofitable for a firm to produce.2.It helps in determining the target capcity for a firm to get the benefit ofminimum unit cost of production.3.With the help of break-even analysis, the firm can determine minimum cost fora given level of output.4.It helps in deciding which products to be produced and which to be bought bythe firm.5.Plant expansion or contraction decisions are often based on the break-evenanalysis of the perceived situation.6.Impact of changes in prices and costs on profits of the firm can also be analyzedwith the help of break even technique.7.Effect of high fixed costs and low variable costs to the total cost can be studied.8.Cash break even chart helps proper planning of cash requirements.9.Helps in finding selling price which will be most beneficial for the firm.10.Emphasizes the importance of capacity utilization for achieving economies.
  16. 16. LIMITATIONS OF BREAK-EVENANALYSIS•Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells usnothing about what sales are actually likely to be for the product at these variousprices.•It assumes that fixed costs (FC) are constant. Although, this is true in the shortrun, an increase in the scale of production is likely to cause fixed costs to rise.•It assumes average variable costs are constant per unit of output, at least in therange of likely quantities of sales. (i.e. linearity)•It assumes that the quantity of goods produced is equal to the quantity of goodssold (i.e., there is no change in the quantity of goods held in inventory at thebeginning of the period and the quantity of goods held in inventory at the end ofthe period).•It is a common knowledge that profit depend on various factors liketechnological improvements, managerial effectiveness,etc.and not only on thelevel of output. The break-even analysis, by assuming that profit are a function ofoutput alone, gives us only a partial view of situation.