COST AND MANAGEMENT

ACCOUNTING (568)

USES OF BREAKEVEN ANALYSIS

Submitted by:

(AH524979)
 ACKNOWLEDGEMENTS

First of all I would be thankful to Allah Almighty without whose blessing and mercies I were not
able to complete this project. This project is refined from a splendid efforts of many people who
contributed regardless of any reward. I thank them from the core of our hearts. May Allah give
them success by leaps and bounds.

I can‟t forget the guidance‟s and knowledge which our kind teachers have provided us. We were
lucky to have such a kind teacher who taught us and with such devotion and zest, which I could
never forget. I thank him from the core of my heart.

In the end we would like to thank to all those people who provided us with useful suggestions,
useful data and facility of composing.
 ABSTRACT

Topic assigned is “Uses of breakeven Analysis” in a specific manufacturing concern. Breakeven

Analysis is an important part of Business management. It is the point where cost or expenses and
revenue are equal: there is no net loss or gain.

Breakeven analysis is used to find safety margin and volume of sales necessary to reach Target
profit. it may help in making decisions in regard with Changes in price, to adjust firms‟ sales
volume or price when there is change in costs, To Make or Buy decisions, Advertising
directions, To make Plant shutdown decisions, Calculation of selling price per unit for a
particular break even point, Choosing the most profitable alternatives, Determining the optimum
sales mix, Deciding on changes in capacity, Helps in determining the optimal level of output,
Determines the minimum cost for the given level of output.

It also helps in taking strategic and long-range planning decisions and Decisions about product
features and pricing.
 TABLE OF CONTENTS
Introduction to the Topic .............................................................................................................................. 1
1.1 Breakeven ..................................................................................................................................... 1
1.2 Breakeven Analysis ....................................................................................................................... 2
1.2.1 Defining Costs ....................................................................................................................... 3
1.2.2 Setting a Price ....................................................................................................................... 4
1.2.3 The Formula .......................................................................................................................... 5
1.2.4 Calculators............................................................................................................................. 6
1.3 Cost-Volume-Profit Analysis ......................................................................................................... 6
1.4 Uses of Breakeven Analysis........................................................................................................... 7
1.5 Limitations..................................................................................................................................... 8
Practical Study............................................................................................................................................. 10
PEL – Pak Elektron Limited .......................................................................................................................... 10
2.1 Company Profile .......................................................................................................................... 10
2.1.1 Appliances Division ............................................................................................................. 11
2.1.2 Power Division .................................................................................................................... 11
2.2 Strategic Plan and Focus ............................................................................................................ 12
2.2.1 Vision ................................................................................................................................... 12
2.2.2 Mission Statement .............................................................................................................. 12
2.2.3 Goals.................................................................................................................................... 12
2.2.4 Competitive Advantage....................................................................................................... 12
2.3 Cost-Volume Profit Analysis ........................................................................................................ 13
2.3.1 Contribution Margin ........................................................................................................... 13
2.3.2 Contribution Margin Ratio .................................................................................................. 14
2.3.3 Breakeven Point .................................................................................................................. 14
2.3.4 Margin of Safety .................................................................................................................. 14
2.3.5 Sale to Earn Target Profit .................................................................................................... 14
2.3.6 Proof of Breakeven Point .................................................................................................... 15
2.4 Use of Breakeven Analysis in PEL ................................................................................................ 15
Data Collection Methods ............................................................................................................................ 17
SWOT Analysis............................................................................................................................................. 19
 4.1 Strengths of PEL .......................................................................................................................... 19
4.2 Weaknesses of PEL ...................................................................................................................... 19
4.3 Opportunities for PEL .................................................................................................................. 19
4.4 Threats for PEL ............................................................................................................................ 20
Conclusion ................................................................................................................................................... 21
Recommendations ...................................................................................................................................... 22
References .................................................................................................................................................. 23
 Assignment II – Cost and Management Accounting (568)

INTRODUCTION TO THE TOPIC

1.1 BREAKEVEN

In economics & business, specifically cost accounting, the break-even point (BEP) is the point at
which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken
even". A profit or a loss has not been made, although opportunity costs have been paid, and
capital has received the risk-adjusted, expected return.

i
Figure 1 BREAK-EVEN POINT

For example, if a business sells fewer than 200 tables each month, it will make a loss, if it sells
more, it will be a profit. With this information, the business managers will then need to see if
they expect to be able to make and sell 200 tables per month.

If they think they cannot sell that many, to ensure viability they could. i

 Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control
of telephone bills or other costs)
 Try to reduce variable costs (the price it pays for the tables by finding a new supplier)
 Increase the selling price of their tables.

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Any of these would reduce the break even point. In other words, the business would not need to
sell so many tables to make sure it could pay its fixed costs.

1.2 BREAKEVEN ANALYSIS

Break-even analysis is used to determine the level of sales and the mix of products, which are
required to just recover al costs incurred during the period. The break-even point is the point at
which cost and revenue are equal. There is neither a profit nor a loss at the break-even point. The
objective of cost-volume-profit analysis is to determine the level of sales and the mix of
products, which are required to achieve a targeted level of profit. Therefore, break-even analysis
may be thought of as a special case of cost-volume-profit analysis, i.e., the determination of the
level of sales and the mix products necessary to achieve a zero level of profit.

Figure 2 BREAK-EVEN CHART (CONVENTIONAL)

Although management typically plans for a profit each period, the break-even point is of
concern. If sales fall below the break-even point in order, losses will be incurred. Management
must determine the break-even point in order to compute the margin of safety, which indicates

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how much sales may decrease from the targeted level before the company will incur losses. The
margin of safety is a criterion used to evaluate the adequacy of planned sales.

Figure 3 PROFIT – VOLUME ANALYSIS GRAPH

If you can accurately forecast your costs and sales, conducting a breakeven analysis is a matter
of simple math. A company has broken even when its total sales or revenues equal its total
expenses. At the breakeven point, no profit has been made, nor have any losses been incurred.
This calculation is critical for any business owner, because the breakeven point is the lower limit
of profit when determining margins.ii

1.2.1 DEFINING COSTS

There are several types of costs to consider when conducting a breakeven analysis, so here's a
refresher on the most relevant.

1.2.1.1 FIXED COSTS

These are costs that are the same regardless of how many items you sell. All start-up costs, such
as rent, insurance and computers, are considered fixed costs since you have to make these
outlays before you sell your first item.

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1.2.1.2 VARIABLE COSTS

These are recurring costs that you absorb with each unit you sell. For example, if you were
operating a greeting card store where you had to buy greeting cards from a stationary company
for $1 each, then that dollar represents a variable cost. As your business and sales grow, you can
begin appropriating labor and other items as variable costs if it makes sense for your industry.

1.2.2 SETTING A PRICE

This is critical to your breakeven analysis; you can't calculate likely revenues if you don't know
what the unit price will be. Unit price refers to the amount you plan to charge customers to buy a
single unit of your product.

1.2.2.1 PSYCHOLOGY OF PRICING

Pricing can involve a complicated decision-making process on the part of the consumer, and
there is plenty of research on the marketing and psychology of how consumers perceive price.
Take the time to review articles on pricing strategy and the psychology of pricing before
choosing how to price your product or service.

1.2.2.2 PRICING METHODS

There are several different schools of thought on how to treat price when conducting a breakeven
analysis. It is a mix of quantitative and qualitative factors. If you've created a brand new, unique
product, you should be able to charge a premium price, but if you're entering a competitive
industry, you'll have to keep the price in line with the going rate or perhaps even offer a discount
to get customers to switch to your company.

One common strategy is "cost-based pricing", which calls for figuring out how much it will cost
to produce one unit of an item and setting the price to that amount plus a predetermined profit
margin. This approach is frowned upon since it allows competitors who can make the product for
less than you to easily undercut you on price.

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Another method, referred to by David G. Bakken of Harris Interactive as "price-based costing"

encourages business owners to "start with the price that consumers are willing to pay (when they
have competitive alternatives) and whittle down costs to meet that price." That way if you
encounter new competition, you can lower your price and still turn a profit. This presentation
from Harris Interactive offers a further explanation of these methods, and About.com offers an
overview of common pricing methods.

1.2.3 THE FORMULA

To conduct your breakeven analysis, take your fixed costs, divided by your price, minus your
variable costs. As an equation, this is defined as:

Breakeven Point = Fixed Costs/(Unit Selling Price - Variable Costs)

This calculation will let you know how many units of a product you'll need to sell to break even.
Once you've reached that point, you've recovered all costs associated with producing your
product (both variable and fixed).

Above the breakeven point, every additional unit sold increases profit by the amount of the unit
contribution margin, which is defined as the amount each unit contributes to covering fixed costs
and increasing profits. As an equation, this is defined as:

Unit Contribution Margin = Sales Price - Variable Costs

Recording this information in a spreadsheet will allow you to easily make adjustments as costs
change over time, as well as play with different price options and easily calculate the resulting
breakeven point. You could use a program such as Excel's Goal Seek, if you wanted to give
yourself a goal of a certain profit, say $1 million, and then work backwards to see how many
units you would need to sell to hit that number. (This online tutorial will show you how to use
Goal Seek.)

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1.2.4 CALCULATORS

There are several online calculators to assist you with your breakeven analysis:

 Case Western Reserve University offers a breakeven analysis calculator that includes a
review of relevant microeconomic terms.
 This financial calculator allows you to chart your costs and profits appear in a graph.
 Inc.com offers a breakeven analysis calculator that requires a user to enter in total annual
overhead and annual year-to-date sales and cost of sales, and lets the user delineate the
period for the YTD calculations in terms of weeks.

1.3 COST-VOLUME-PROFIT ANALYSIS

Cost-Volume-profit (CVP), in managerial economics is a form of cost accountingiii. It is a

simplified model, useful for elementary instruction and for short-run decisions.

Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven

analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both
fixed and variable costs). At this breakeven point (BEP), a company will experience no income
or loss. This BEP can be an initial examination that precedes more detailed CVP analysis.

Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The
assumptions underlying CVP analysis are:

 The behavior of both costs and revenues is linear throughout the relevant range of
activity. (This assumption precludes the concept of volume discounts on either purchased
materials or sales.)
 Costs can be classified accurately as either fixed or variable. Changes in activity are the
only factors that affect costs.
 All units produced are sold (there is no ending finished goods inventory).
 When a company sells more than one type of product, the sales mix (the ratio of each
product to total sales) will remain constant.

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The components of Cost-Volume-Profit Analysis are:

 Level or volume of activity

 Unit Selling Prices
 Variable cost per unit
 Total fixed costs
 Sales mix

CVP assumes the following:

 Constant sales price;

 Constant variable cost per unit;
 Constant total fixed cost;
 Constant sales mix;
 Units sold equal units produced.

These are simplifying, largely linearizing assumptions, which are often implicitly assumed in
elementary discussions of costs and profits. In more advanced treatments and practice, costs and
revenue are nonlinear and the analysis is more complicated, but the intuition afforded by linear
CVP remains basic and useful.

One of the main Methods of calculating CVP is Profit volume ratio:

(Contribution /sales)*100 = this gives us profit volume ratio.

Contribution stands for Sales minus variable costs. Therefore it gives us the profit added per unit
of variable costs.

1.4 USES OF BREAKEVEN ANALYSIS

 Breakeven analysis allows the firm to determine at what level of operations it will break
even (earn zero profit) and to explore the relationship between volume, costs, and profits.
It helps the management that at current costs of products how many numbers of units
must be sold to at least recover the cost of producing the product.

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 It's a cheap screening device. Discounted cash flow techniques require large amounts of
expensive-to-get data. Break even analysis can tell you whether or not it's worthwhile to
do more intensive (costly) analysis.iv
 It provides a handle for designing product specifications. Each design has implications
for cost. Costs obviously affect price and marketing feasibility. Breakeven permits
comparison of possible designs before the specifications are frozen.
 It serves as a substitute for estimating an unknown factor in making project decisions. In
deciding whether to go ahead or to skip it, there are always variables to be considered:
demand, costs, price, and miscellaneous factors. When most expenses can be determined,
only two missing variables remain profit (or cash flow) and demand. Demand is usually
tougher to estimate. By deciding that profit must at least be zero, (the break even point),
you can then fairly simply find the demand you must have to make the project a
reasonable undertaking.
 Breakeven gives you a way to attack uncertainty, to get onto the target if not the bull's-
eye.
 A break even analysis is a management control tool that approximates how much you
must sell in order to cover your costs with NO profit and NO loss. Profit comes after the
breakeven point.
 It enables you to determine with great accuracy whether or not your idea is a profitable
one. Best of all, you can use this tool to evaluate every product or service you offer.

1.5 LIMITATIONS

It is important to understand what the results of your breakeven analysis are telling you. If, for
example, the calculation reports that you would break even when you sold your 500th unit,
decide whether this seems feasible. If you don't think you can sell 500 units within a reasonable
period of time (dictated by your financial situation, patience and personal expectations), then this
may not be the right business for you to go into. If you think 500 units is possible but would take
a while, try lowering your price and calculating and analyzing the new breakeven point. The
following are the limitations of a Break-even analysis: i

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 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. Although, this is true in the short run, 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 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).

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PRACTICAL STUDY

PEL – PAK ELEKTRON LIMITED

The organization that I selected for my assignment is PEL. Pak Elektron Limited commonly
known as PEL is an electronic company that produces electronic goods in Pakistan. I will be
discussing the company as well as its marketable securities in my research report. I have
contacted Tauqir Akhtar, Gulzaib Mohy ud din-HR Executive, Muhammad Rashid Hussain-
Manager Finance and have researched several previous reports on PEL.

2.1 COMPANY PROFILEv

Pak Elektron Limited (PEL) is the pioneer manufacturer of electrical goods in Pakistan. It was
established in 1956 in technical collaboration with M/S AEG of Germany. In October 1978, the
company was taken over by Saigol Group of Companies. Since its inception, the company has
always been contributing towards the advancement and development of the engineering sector in
Pakistan by introducing a range of quality electrical equipments and home appliances and by
producing hundreds of engineers, skilled workers and technicians through its apprenticeship
schemes and training programs.

The company comprises of two divisions:

Appliances Division
Power Division

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2.1.1 APPLIANCES DIVISION

This Division of PEL consists of appliances manufacturing.

 PEL Air Conditioners

 PEL Refrigerators
 PEL Deep Freezers

2.1.2 POWER DIVISION

PEL Power Division manufactures energy meters, transformers, switchgears, Kiosks, compact
stations, shunt capacitor banks etc. All these electrical goods are manufactured under strict
quality control and in accordance with international standards. PEL is one of the major electrical
equipment suppliers to Water and Power Development Authority (WAPDA) and Karachi
Electrical Supply Corporation (KESC), which are the largest power utilities in Pakistan. Over the
years, PEL electrical equipment has been used in numerous power projects of national
importance within Pakistan. PEL has the privilege of getting its equipment approved and
certified by well-reputed international consultants such as:

Preece, Cardew and Rider, England

Harza Engineering Company, USA
Snam Progeti, Italy
Societe Dumezm, France
Miner & Miner International Inc. USA
Ensa, France

In spite of stiff competition from emerging local and multinational brands, PEL Group's
appliances and electrical equipments have remained in the spotlight due to constant innovation.
Strategic partnership with multinationals of repute have enabled the PEL Group to incorporate
new technologies into existing product ranges, thus giving the Pakistani market access to
innovative, affordable and quality products.

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2.2 STRATEGIC PLAN AND FOCUS vi

2.2.1 VISION

To excel in providing engineering goods and services through continuous improvement.

2.2.2 MISSION STATEMENT

The mission statement of PEL is:

To provide quality products and services to the complete satisfaction of our customers
and maximize returns for all stakeholders through optimal use of resources.
To focus on personal development of our HR to meet future challenges.
To promote good governance, corporate values and social responsibility.

2.2.3 GOALSvii
2.2.3.1 NON-FINANCIAL GOALS

To add a new product to its range in every third year for increasing the sales volume.
To set an image as the best quality of local home appliances
To set an image as the best quality of local power division products

2.2.3.2 FINANCIAL GOALS

To obtain a real (inflation-adjusted) grown in earning per share of 8-10% per year over
time
To increase the market share by the end of every year

2.2.4 COMPETITIVE ADVANTAGE

PEL is the pioneer manufacturer of electrical goods in Pakistan

PEL has a huge distribution network all over in Pakistan

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Pak Elektron Limited (PEL) has been awarded third time in a row with 7th Annual
Environment Excellence Award, 2010 for best Health, Safety and Environmental
performance
PEL has been awarded second time with 4th CSR National Excellence Award 2009, for
best efforts within the multi-dimensional scope of CSR and a special award for „Best
Information Material On CSR‟

2.3 COST-VOLUME PROFIT ANALYSIS

Breakeven Point is the level of sales requires to reach a position of no profit, no loss. At
breakeven point, the contribution is just sufficient to cover fixed cost. The organization starts
earning profit when the sales cross the Break-even point. Breakeven point can be calculated
either in terms of units or in terms of cash or in terms of capacity utilization. It can be calculated
as follows:viii

Breakeven Point = Fixed Costs/(Unit Selling Price - Variable Costs)

2.3.1 CONTRIBUTION MARGIN

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2.3.2 CONTRIBUTION MARGIN RATIO

2.3.3 BREAKEVEN POINT

2.3.4 MARGIN OF SAFETY

2.3.5 SALE TO EARN TARGET PROFIT

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2.3.6 PROOF OF BREAKEVEN POINT

2.4 USE OF BREAKEVEN ANALYSIS IN PEL

The year 2009 has registered steady growth in Appliances division. Sales grew to Rs.2.898
billion from Rs. 2.642 billion over corresponding period showing an increase of 10%. This
performance is noteworthy especially in view of ongoing power crisis.

Demand for electrical goods in Pakistan, despite energy crisis and inflationary pressure, is on the
rise again and is mainly attributable to shift of majority of home appliances products from
„Luxury‟ to „Necessity‟ cadre.

PEL seeing a shift in demand of ACs from urban to rural areas whereas similar shift in demand
has already been witnessed for last 5 to 7 years in Refrigerators with total market increasing from
200,000 to over 1 million units. Similar trend was observed in Microwave ovens and Washing
machines.

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Despite shortage of power and load shedding, surge in demand and sales of air conditioners is
seen. This is due to the fact that consumers have buying power for this product and want to use
air conditioners even for smaller durations when power supply is there.

This is all because PEL using its spending efficiently. The Research and development and the
Finance Department are solely working on ways to improve the performance of PEL.

PEL takes best advantage of the Breakeven Analysis, driven from its sales and production cost:

 Measurement of actual Performance

 Comparison of actual Performance with budgeted performance to detect deviation
 Analysis of the causes of variations and reporting
 Budget Fixing: Targets are fixed for each function relating to the responsibilities of
individual executives
 Strategies are made for future outcomes
 Market response is checked, and forecast is done
 Earnings per share and share rate is analyzed
 Marketable securities are bought/sold (whatever required)

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DATA COLLECTION METHODS

Several ways for data collection were adopted to gather such information about PEL.

1. Primary Data (Tauqir Akhtar, Gulzaib Mohy ud din-HR Executive, Muhammad Rashid
Hussain-Manager Finance)
a. Communicating via Email
Hiring Procedures
o Hiring System – Team / Panel designation for hiring people
o Structured interview
o Unstructured interview
o Behavioral interview
Does the upper level management designate work to the employees by
defining time & task to be delivered or just the goal is told to the
employees and it is their headache to complete it taking their own
decisions?
o Employee power?
o Creativity of employee?
o Freedom of decision? OR
o Defined Procedures/Protocols?
What are the Strengths for PEL in terms of internal environment
(product quality, internal departments, salaries, incentives, rewards,
bonuses for motivation of employees etc)?
What are the Weaknesses for PEL in terms of internal environment
(drawbacks of PEL including employees‟ point of view, for example
taking much time in training employees)?
What are the Opportunities (marketing, production, cost, financial point
of views) for PEL from the external environment?
What are the Threats (marketing, production, cost, financial point of
views) for PEL from the external environment?
Type of meetings conducted

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o Annual / quarterly basis?

o Agenda of meetings
Who conducts the meetings?
What are the responsibilities of people attending the meetings?
Demand of PEL products in the market?
Supply of PEL products in the market?
Different time periods, that is yearly analysis of PEL supply and demand
in the market?
What are the marketable securities of PEL (treasury sector, treasury
notes, federal agency sector, repurchase agreements etc)?
Product Promotion Strategy?
o Who makes the strategy?
o Who implements it?
o How is it implemented? (for example through surveys or
print/electronic media ads etc)
o How changes are incorporated on the basis of feedback
from the customers/ market?
b. Telephonic conversation to clear certain issues
2. Secondary Data (References are given at the end of the report)
a. Data collected from PEL website
b. Research Reports of various scholars
c. Internet surfing

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SWOT ANALYSIS
4.1 STRENGTHS OF PEL

PEL has the following strengths:

 Brand Name
 Strategic Partners with LG
 Strong dealer Network
 Quality products
 Best sales services
 Market leader in WRAC
 Number 2 in refrigerator in Pakistan
 Strong management team
 Distribution of authority
 Research and Development department
 Free customer service

4.2 WEAKNESSES OF PEL

Like others companies PEL has some weaknesses too. PEL looses competitive edge in the
following areas:

 Financial Problems
 Lack of Advertisement
 System variations
 Lack of Product Range
 Less Utilization of Capacity

4.3 OPPORTUNITIES FOR PEL

There are several opportunities for PEL:

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 Rebuilding Projects
 Partnership with LG
 Exploration of Market in Pakistan
 Increase in Product range
 Export Quality
 Increase in Product Capacity

4.4 THREATS FOR PEL

Following are the main threats for PEL:

 Strong Competition
 Introduction of China‟s Products in the Market
 Price War
 Slow Growth rate in Pakistan
 Instability of Government
 Tax Department
 World Trade Organization

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CONCLUSION

PEL should concentrate on promotion of their products and try to enhance the Target Market
of split. PEL should try to capture the remove area market especially in Rural areas. To get
more market share it needs qualitative products with innovative styles, and aggressive
marketing activities to create awareness among public regarding their appliances product.
More attractive Incentives should be designed to get more dealers interest in their products.
To make their products technically round they need more technology advancement especially
after failure of their T.V. in market. More innovative & new technology is needed.

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RECOMMENDATIONS

 Adopt a true decentralized organization setup which gives all employees to take
part in decision making.

 The company should have a strong marketing information system to make proper
forecasts.

 The company should announce two holidays in a week to improve the labor
productivity level.

 Make sure that the HR department is functioning properly.

 Allocate more budget to the marketing department.

 More focus on PULL strategy in its promotion mix.

 Shorten the cash conversion cycle.

 Focus on direct selling of its products to its customers.

 Should constantly add technology in its products and systems.

 Speed up delivery process by establishing/expanding its stores in areas of high

demand.

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REFERENCES

i
- http://en.wikipedia.org/wiki/Break-even_(economics)
ii
- http://entrepreneurs.about.com/od/businessplan/a/breakeven.htm
iii
- http://en.wikipedia.org/wiki/Cost-Volume-Profit_Analysis
iv
- http://www.cabusinessadvisor.com/Mgmt/FinAnalysis/BreakE.htm
v
- http://www.pel.com.pk

vi
- http://www.pel.com.pk

vii
- http://www.scribd.com/doc/18658535/PEL-Pakistan

viii
- http://www.scribd.com/doc/19531352/Costing-System-in-batch-production-PEL

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