Breakeven Analysis
Breakeven Analysis: It
is a method of studying the behavior of profit in response to the changes in
volume, costs and prices. It shows the relationship between output, revenue and
costs to determine the minimum sales volume to avoid losses and the sales
volume at which the profit goal of the firm will achieved.
Breakeven point:
Break-even point of an
enterprise is a pint where total revenue/sale proceeds/sale or output equals
total cost. It indicates that level of output/sales/sale proceeds/revenue at
which the firm recovers all its costs and neither earns a profit nor incurs any
loss. In other words this is a point of zero profitability. Once the firm
crosses its break-even point, it starts earning profit.
Break-Even Point can be seen from
the following example.
Output(unit)
|
Total Cost(Tk.)
|
Total Revenue(Tk.)
|
Profit(Tk.)
|
100
|
600
|
400
|
-200
|
200
|
800
|
800
|
0
|
300
|
1100
|
1200
|
+100
|
No firm or enterprise can
remain satisfied with the break-even level of output. Because:
(a) if
a firm operates below the break-even point it can not survive for a longer time, as it will then be functioning only with a drain on its own
equity by not being able to sell its products at the cost price of production.
(b) as the aim of any firm is to earn more and more profit each
concern would like to operate at a level above its break-even.
(c) the higher the profit above break even point, the higher is
the margin of safety, and the lower the profit above break-even point, the
lower is the margins of safety. At break-even point the margin of safety is
nil.
Margin
of Safety:
Margin
of safety is the difference between break-even output level and actual output
level.
Important concepts of
Breakeven Analysis:
Fixed Cost (FC): Fixed
Costs consist of all those expenses, which are not directly related to the
volume of production. It remains fixed regardless of the level of production. Those costs are rent on land and building, interest on
capital, insurance, salaries of permanent staffs, depreciation, expenses on
research and product development, expenses of training the employees etc.
Variable Costs: Variable
costs are directly related with the level of production. It means that with the
change in the volume of production the cost also varies. These costs consist of expended of raw materials, power and
fuel consumed by the factory, taxes, wages of laborers, etc.
There are some costs, which are
clubbed into either semi-fixed or semi-variable category. For example fixed assets depreciate due to obsolescence and
wear and tear. The former is unrelated to the volume of output (fixed cost)
where the latter is related to it (variable cost).
Salesman may be paid both a
fixed amount of salary (fixed cost) and a commission based on the volume sold
(variable cost).
Assumptions of Break-Even
Analysis:
(a) Fixed
costs and variable costs can be ascertained.
(b) The
behavior of fixed costs and variable costs will remain unchanged.
(c) Product
specifications and methods of manufacturing will not undergo a change.
(d) Operating efficiency will not increase or decreas3e.
(e) There
will not be any Change in prcing due to change in volume, competition etc.
(f)
The number of units of sales will coincide with the
units produced, so that there is no closing or opening stock. Alternatively,
the changes in opening and closing stocks are insignificant and they are valued
at the same price or at variable cost.
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