Break-Even AnalysisThe break-even point is the level of sales at whichrevenue equals expenses and net income is zero.
DefinitionThe break-even point is the point at which income matchesexpenditures. Typically, initial expenditures are high. It takestime for the income to reach the same level. The break-evenpoint can apply to a product, an investment, or the entirecompanys operations.
CostsFixed (Indirect/Overheads) – are not influenced by the amount produced but can change in the long run e.g., insurance costs, administration, rent, some types of labour costs (salaries), depreciation on equipment and machineryVariable (Direct) – Variable cost directly with the amount produced, e.g., raw material costs, some direct labour costs, some direct energy costs.
Formula Method for Determining BEPBEP in terms of Physical UnitsBEP = TFC / P – AVCWhere,BEP = the break even pointTFC = the total fixed costP = the selling priceAVC = the average variable cost
PROBLEMGiven the following total cost revenue functions, determine the BEP: TFC = Rs.480 AVC = 10 Q Selling Price = 50 Q (Here, Q is Units of cost sold) SOLUTION BEP = TFC / P – AVC = 480 / 50 – 10 = 480 – 40 BEP = 12 Units.
BEP in terms of Sales Value Formula1. BEP = TFC / CR2. CR = TR – TVC / TRWhere, BEP =the break even point TFC = the total fixed cost TVC = the total variable cost TR = the total revenue CR = the contribution ratio
PROBLEMA firm incurs fixed cost of Rs. 4000 and variable cost of Rs. 10000 and its sales receipts are Rs. 15000.Determine the BEP. TR = Rs.15000 TVC= Rs.10000 TFC= Rs.4000
The margin of safetyThe difference between actual output and the break-evenoutput is known as the margin of safety sales – – Break-even Point = Margin of safety
Assumption1. Cost can be bifurcated in to variable and fixed components.2. Fixed cost will remain constant during the relevant volume range of graph.3. Variable cost per unit will remain constant during the relevant volume range of graph.4. Selling price per unit will remain constant irrespective of the quantity sold within the relevant range of the graph.5. In the case of multiproduct companies, sales mix remain constant.6. Production and sales volume are equal.
LIMITATIONS OF BREAK-EVEN ANALYSIS BEA is not an effective tool for long range use as it should be restricted to short range only. Selling cost is specially very difficult to handle breakeven analysis. The area included in breakeven analysis should be limited as it leads to bad performance. Cost in particular period may not be caused entirely by the output in that period. In BEA, everything is assumed to be constant, this implies a static condition, hence it is not suited to a dynamic situation.
BEA assumes that profits are the only functions of output ignoring the patent fact that they are also caused by other factors. Many other shortcomings- BEA fails to consider the impact of • Technological change. • Better management. • Division of labour. • Improved productivity and such other factors influencing profits.
Uses of BEA BEA provides microscopic view of profit structure BEA can be of great help for cost control in business BEA serves the purpose of profit prediction and tool for profit making BEA used for determining the “safety margin” to which firm can permit decline in sales without causing losses
COST CONTROL *DEFINATION*“The process or activity on controlling costs associated withan activity, process or company”. OR“The practice of managing and/or reducing business expensesare known as cost control”.
*ABOUT COST CONTROL* Profit maximisation is the major objective of business firm, even if the profit is not maximised in long run, the firm must be able to earn sustained profits. A planned programme of cost reduction is essential for effective cost control. Cost control is not a cost reduction. There should be a consortium approach, to achieve a goal of cost minimization.
TECHNIQUES OF COST CONTROL STANDARD COSTING *DEFINATION* “A technique of using standard cost for the purpose of cost control is known as standard costing” OR “A management tool used to estimate the overall cost of production assuming normal operations”.
*ABOUT STANDARD COSTING* Standard costing is formed by collecting all kinds of various information like material, labour and overhead cost from various sources. The actual cost can be ascertained only when the production is undertaken. Cost control, right decisions and elimination of inefficiencies are some of the advantages of standard costing.
BUDGETARY CONTROL*DEFINATION* “Budget control is that type of control in which, controller compares actual result with budget data and identify the difference and corrects the cause of difference”. *ABOUT BUDGETARY CONTROL* It clearly defines the area of responsibility required by the managers of budget centres for achievement of budget targets. Budget control must be made flexible so that according to changes we can change our budget. Budgetary control must be through top level management for successful budgetary control.
CASE STUDYRead the following case study and calculate the break-evenpoint:Jessica wanted to start her own company instead of workingfor someone else. She had been thinking about different low-risk ventures she can start with minimum capital.She realized that she has always enjoyed making homemadecakes. Her friends loved the cakes she made for them.She purchased backing yeast of Rs 2000, grain sugar of Rs3200 ,Eggs for Rs 260 & Flour for Rs 420 Jessicas rent is 2000, 400 for phone & Internet charges,Electricity chrgs Rs 500 and sales of cake is Rs 10000Determine the breakeven point in terms of sales
Solution Formula :- BEP(Sales)= ____ Fixed Cost ________ Contribution margin ratio Where contribution = (Selling price – variable cost)/Selling price Sales 10000 Variable Cost 5880 (2000+3200+260+420) Fixed Cost 2900 (2000+400+500)Contribution Margin ratio is(10000-5880)/10000) = 0.4BEP = 2900 = Rs.7250 0.4At the sales value of Rs 7250(BEP),there is no profit no loss.