BREAK EVEN ANALYSIS

BREAK-EVEN POINT IS THAT LEVEL OF OUTPUT WHERE TR = TC.

THIS IS THE POINT OF NO PROFIT - NO LOSS.

IT IS THAT LEVEL OF OUTPUT WHERE THE LOSS STOPS & PROFIT STARTS.

BEYOND BEP, INCREASE IN SALES RESULTS IN PROFIT AND

DECREASE IN SALES RESULTS IN LOSS.

 DIAGRAMATIC REPRESENTATION OF BEP

UNDER DIFFERENT COST / REVENUE CONDITIONS

COST/REV

TR

PROFIT
LOSS TC

BEP = OQ

TFC

O Q OUTPUT
COST/REV
TR

TC

P
BEP = OQ
TFC

O Q OUTPUT
COST/REV

TC

TR

BEP = OQ
P

TFC

O Q
OUTPUT
 TR = TC

P × Q = TFC + TVC

P × Q = TFC + Q × AVC

P × Q – Q × AVC = TFC

Q (P – AVC) = TFC

Q = TFC / (P – AVC)

Q = TFC / C.M. . . . .(CONTRIBUTION MARGIN)

 A FIRM PRODUCES A PRODUCT & SELLS IT AT Rs.10. THE VARIABLE
COST IS Rs.7 PER UNIT. IF ITS TOTAL FIXED COST IS Rs.3,00,000, WHAT
SHOULD BE THE MINIMUM SALES VOLUME TO COVER THE TOTAL COST?

BEP(Q) = TFC / (P – AVC)

BEP(Q) = 3,00,000 /(10 – 7)

BEP(Q) = 1,00,000 UNITS

THE FIRM’S SALES VOLUME MUST BE AT LEAST 1,00,000 UNITS TO COVER TOTAL COST.
COST/REV TR COST/REV TR
TC
TC

TFC

TFC

O OUTPUT O Q’ OUTPUT
Q

WITH INCREASE IN TFC & REDUCTION IN AVC, BEP INCREASES.

 DEGREE OF OPERATING LEVERAGE

Q (P – AVC)
DOL = . . . . . .(1)
Q (P – AVC) - TFC

IT GIVES THE ELASTICITY OF PROFIT W.R.T. OUTPUT

IF P = 15, AVC = 10, TFC = 200 & SALES (Q) = 60

60 (15 – 10) 300 =3
200 DOL = =
BEP = = 40 60 (15 – 10) - 200 100
5

IT MEANS 1% INCREASE IN SALES LEADS TO 3% INCREASE IN PROFIT

 IF THE FIRM INCREASES TFC TO 300 & AVC IS REDUCED TO 9,

300 60 (15 – 9)
BEP = = 50
DOL = =6
6 60 (15 - 9) - 300

SO, WE FIND THAT BY INCREASING TFC FROM 200 TO 300 & REDUCING

AVC FROM 10 TO 9, BEP RISES FROM 40 TO 50 BUT DOL RISES FROM 3

TO 6
APPLICATIONS OF BEP ANALYSIS
 1] TO DETERMINE THE QUALITY OF THE PRODUCT

SUPPOSE, TFC = 1,00,000 & PRICE = Rs.50. THERE ARE TWO GRADES OF
RAW MATERIAL. IF SUPERIOR QUALITY OF MATERIAL IS USED, AVC IS
Rs.30. OTHERWISE AVC WOULD BE Rs.25.

LET AVC1=30 & AVC2=25

BEP1= 1,00,000/(50 – 30) = 5000 & BEP2= 1,00,000/(50 – 25) = 4000

IF EXPECTED DEMAND IS LESS THAN 5000, IT WOULD NOT BE

ADVISABLE TO USE SUPERIOR QUALITY OF MATERIAL.

 2] TO SELECT THE LEVEL OF TECHNOLOGY

THERE ARE THREE TYPES OF PLANT I, II & III. TFC AND AVC WITH

RESPECT TO THESE THREE PLANTS ARE GIVEN BELOW;

PLANT I II III

TFC 80,000 1,80,000 2,80,000

AVC 4 2 1

PRICE 8 8 8

BEP 80,000/4 1,80,000/6 2,80,000/7

IF EXPECTED DEMAND IS 25000 UNITS, PLANT I IS ECONOMICALLY

FEASIBLE.
 3] TO MAKE OR BUY

A BICYCLE MANUFACTURER CAN MAKE THE SEAT HIMSELF OR HE CAN

OUTSOURCE IT AT Rs.12 PER SEAT.

IF HE PRODUCES HIMSELF, THE MACHINERY WOULD COST Rs.50,000 AND

MAKING CHARGES WOULD BE Rs.2 PER SEAT.

BEP IN THIS CASE WOULD BE 50,000/(12 – 2) = 5000.

IF DEMAND FOR BICYCLE IS MORE THAN 5000, THEN ONLY HE SHOULD

MAKE SEATS.