BREAK EVEN POINT & ANALYSIS

 The selling price of a product is derived as shown below:

(a) Direct Material costs + Direct labour costs + Direct expenses = Prime cost (b) Prime cost + Factory overhead = Factory cost (c) Factory cost + Office and administrative overhead = Costs of production (d) Cost of production + Opening finished stock - Closing finished stock = Cost of goods sold (e) Cost of goods sold + Selling and distribution overhead = Cost of sales (f) Cost of sales + Profit = Sales (g) Sales/Quantity sold = Selling price per unit

DEFINITION break-even
At this point the income of the business exactly equals its expenditure. If production is enhanced beyond this level, profit shall accrue to the business and if it is decreased from this level, loss shall be suffered by the business.

DEFINITION
The break even point is the point where the gains equal the losses. The point defines when an investment will generate a positive return. The point where sales or revenues equal expenses. The point where total costs equal total revenues. There is no profit made or loss incurred at the break even point. It is the lower limit of profit when prices are set and margins are determined.

Equations
Break-even point
Total Revenues = Total Costs Total Revenues - Total Costs = Zero Profit

 Profit = Sales (Fixed cost + Variable costs = s x Q (FC + v x Q) Break-even quantity = Fixed cost Selling price/unit Variable cost/unit = FC s - v Break-even sales = Fixed cost x selling price/unit Selling price/unit Variable cost/unit Contribution = Sales Variable costs Contribution/unit = selling price/unit Variable cost/unit = Profit x sales Contribution

.
Contribution/unit = selling price/unit Variable cost/unit M.S =actual sales breakeven sales = Profit x sales Contribution M.S. as a per cent of sales = (M.S./Sales) x 100

Break-Even Formula - Units

Total Fixed Costs Sales Price (per unit) - Variable Cost (per unit) F Profit Q P -V P-V= Contribution Margin $100,000 12 - 4 = 12,500 units If fixed costs are $100,000, unit sales price is $12, and unit variable cost is $4, the break-even point is 12,500 units

Use CVP Analysis to

Compute the break-even point Study interrelationships of
prices volumes fixed and variable costs contribution margins profits

Equations
Contribution Margin (CM)
Sales Price - Variable Cost = CM per unit Revenue - Total Variable Costs = CM in total

Contribution Margin Ratio (CM%) Sales Price Variable Cost Sales Price

FORMULA
Break even point of Sales= 1. Fixed cost x SP per unit Contribution per unit
2. Fixed Cost Total Contribution x Total Sales

Sales for a desired profit=

(Fixed cost + Desired profit) (P/V Ratio)

Where as, P/V ratio= Contribution per unit Selling price per unit = Total contribution Total sales M.S= profit P/V ratio

Using Cost-Volume-Profit Analysis

Setting a target profit Enter before-tax profit in numerator $100,000 + $30,000 12 - 4 12

= $195,000

If fixed costs are $100,000, unit sales price is $12, unit variable cost is $4, and the desired before-tax profit is $30,000, the required sales are $195,000

CVP
Setting a target profit Convert after-tax profit to before-tax profit Before-tax profit = 48000 6000= 1- 20% After-tax profit 1 - tax rate

At a 20% tax rate, an after-tax profit of $48,000 equals a before-tax profit of $60,000

CVP
Setting a target profit Convert after-tax profit to before-tax profit Enter before-tax profit in numerator $100,000 + $60,000 12 - 4 = $240,000 12 If fixed costs are $100,000, unit sales price is $12, unit variable cost is $4, and the desired after-tax profit is $48,000, the required sales are $240,000

CVP Calculations for a Single Product Cost-Volume-Profit (CVP) Analysis

Units required to F Profit achieve target Q P - V pretax profit F= fixed cost

P = selling price per unit

P - V = contribution margin per unit

To find the breakeven point in units, set Profit = 0.

s

Q2: CVP Calculations for a Single Product . Sales $ required to achieve target pretax profit . where

F Profit CMR

F = total fixed costs CMR = contribution margin ratio = (P- V)/P

Note that CMR can also be computed as

Total Revenue Total Variable Costs CMR Total Revenue

To find the breakeven point in sales $, set Profit = 0.

Q2: Breakeven Point Calculations

Bills Briefcases makes high quality cases for laptops that sell for $200. The variable costs per briefcase are $80, and the total fixed costs are $360,000. Find the BEP in units and in sales $ for this company.

F 0 BEP in units P V F 0 BEP in sales $ CMR

F (P V ) / P

. Q2: CVP Graph Draw a CVP graph for Bills Briefcases. What is the pretax profit if Bill sells 4100 briefcases? If he sells 2200 briefcases? Recall that P = $200, V = $80, and F = $360,000. TR TC

$1000s $600 $360

2200 s

3000

4100

units

FORMULA
Break even point (of output) = (fixed cost) / (contribution per unit) Where,
Contribution=selling cost-variable cost Fixed cost= Contribution- profit

CALCULATION OF THE BREAK EVEN POINT

VARIABLE COSTThey are directly related to the volume of sales: that is these cost increase in proportion to the increase in sales and vice versa.

FIXED COST

Fixed costs continue regardless of how much you can sell or not sell, and can be made up of such expenses as rent, wages, telephone account and insurance. These cost can be estimated by using last years figure as a basis, because they typically do not change.

Formula= FIXED COST VARIABLE COSTS

 At break even point, the desired profit is zero. In case the volume of output or sales is to be computed for a desired profit, the amount of desired profit should be added to fixed cost is the formula given above. Units for a desired profit= Fixed cost+ desired profit Contribution per unit

CASH BREAK EVEN POINT

It is the point where cash breaks even i.e. the volume of sales where cash realization on account of sales will be sufficient to meet the immediate cash liabilities. The label of activities where the total costs under two alternatives are same While calculating this point cash fixed costs (i.e. excluding fixed share of depreciation and deferred expenses) and cash contribution (i.e. after making adjustments for variable share of depreciation etc.) are considered.

 The point helps the management in determining the level of activities below which there are chances of insolvency on account of the firms inability to meet the cash obligation unless alternatives are made.

FORMULA FOR CASH BREAK EVEN POINT

Cash break even point (in units) =

(Cash fixed cost) / (cash contribution per unit)

Cash break even point (in sales Rs.) =

(Cash fixed cost) / (cash contribution per unit) x selling price per unit

BREAK EVEN ANALYSIS

It refers to the ascertainment of level of operations where total revenue equals to total costs. Analytical tool to determine probable level of operation. Method of studying the relationship among sales, revenue, variable cost, fixed cost to determine the level of operation at which all the costs are equal to the sales revenue and there is no profit and no loss situation. Important techniques is profit planning and managerial decision making.

DEFINATIONS USED IN BREAK EVEN POINT Fixed Cost: The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed. Variable Unit Cost: Costs that vary directly with the production of one additional unit. Expected Unit Sales: Number of units of the product projected to be sold over a specific period of time. Unit Price: The amount of money charged to the customer for each unit of a product or service.

DEFINATIONS CONT
Total Variable Cost: The product of expected unit sales and variable unit cost. (Expected Unit Sales * Variable Unit Cost ) Total Cost: The sum of the fixed cost and total variable cost for any given level of production. (Fixed Cost + Total Variable Cost ) Total Revenue: The product of expected unit sales and unit price. (Expected Unit Sales * Unit Price ) Profit (or Loss): The monetary gain (or loss) resulting from revenues after subtracting all associated costs. (Total Revenue - Total Costs)

DEPENDENCE
Break even analysis depends on the following variables: The fixed production costs for a product. The variable production costs for a product. The product's unit price. The product's expected unit sales [sometimes called projected sales.] On the surface, break-even analysis is a tool to calculate at which sales volume the variable and fixed costs of producing your product will be recovered. Another way to look at it is that the break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for your company. It can also use break even analysis to solve managerial problems.

ADVANTAGE
It is cheap to carry out and it can show the profits/losses at varying levels of output. It provides a simple picture of a business - a new business will often have to present a break-even analysis to its bank in order to get a loan.

LIMITATIONS
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 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 .)

Introduction to Breakeven Analysis

Breakeven Analysis in the context of Production planning addresses the decision of whether to make or buy a product. Making the product involves two cost elements:
Fixed costs such as machine renting cost and operation expenses Variable costs such as raw material cost

Buying the product involves only one cost element, the selling price. However, the price may either be constant or variable based on the quantity.

Breakeven point
Make or buy
Buy Cost (BC) = pQ Cost Making is better

Make Cost (MC) = FC + vQ

Buying is better Variable cost: vQ

Fixed Cost: FC Savings : S = BC MC = pQ FC vQ Breakeven: S = 0, pQ = FC + vQ Quantity (Q) Q Gaafar 2007

Non linear breakeven

Make or buy
Buy Cost (BC) = pQ $

Assumptions: (1) Price varies with demand; (2) We have fixed costs; (3) We have constant variable cost.
Make Cost (MC) = FC + vQ

Break-even output

maximum savings

Break-even output

Fixed Cost: FC

p = (a bQ) Savings (S) = pQ FC vQ = (a bQ)Q FC vQ S = aQ bQ2 (FC+vQ) S = (a-v)Q bQ2 FC .. (1)

Set (1) equal to zero to determine breakeven. Differentiate (1) with respect to Q and set the result equal to zero to find Q that maximizes the sa Gaafar 2007

Suppose a firm is considering manufacturing a new product and the following data have been provided: Sales price $12.50/unit Equipment cost $200,000 Overhead cost $50,000/year Operating and maintenance cost $25/operating hour Production time/1000 units 100 hours Planning horizon 5 years Minimum attractive rate of return 15%

Determine the sales volume that would make manufacturing this product profitable.
[10,966]

A particular product has a unit price that starts at $78 with a $0.1 discount for each unit purchased. If the fixed cost are $800/month and the variable cost per unit is $30/unit, determine the demand quantity that maximizes the savings of making and the breakeven quantities. [240, 17.28, 462.72]

20. Nunn Company produces a single product. Following is cost information: Variable Cost Per Unit $15 10

Fixed Cost Manufacturing costs $35,000 Non-manufacturing costs 60,000

If the product sells for $60, how many units must be sold to break even? a. 1,000 b. 2,375 c. 2,714 d. 3,800

Q3: CVP Analysis for Multiple Products

When a company sells more than one product the CVP calculations must be adjusted for the sales mix. The sales mix should be stated as a proportion
of total units sold when performing CVP calculations for in units.

of total revenues when performing CVP calculations in sales $.

Q3:

Multiple Product Breakeven Point

Peggys Kitchen Wares sells three sizes of frying pans. Next year she hopes to sell a total of 10,000 pans. Peggys total fixed costs are $40,800. Each products selling price and variable costs is given below. Find the BEP in units for this company.

Expected sales in units Selling price per unit Variable costs per unit Contribution margin per unit

Small Medium 2,000 5,000 $10.00 $4.00 $6.00

Large Total 3,000 10,000

$15.00 $18.00 $8.00 $11.00 $7.00 $7.00

First note the sales mix in units is 20%:50%:30%, respectively; then compute the weighted average contribution margin:
:Cost-Volume-Profit Analysis

Sl

Q3: Multiple Product Breakeven Point

Next, compute the BEP in terms of total units:

Total units needed to breakeven

But 6,000 units is not really the BEP in units; the BEP is only 6,000 units if the sales mix remains the same.

The BEP should be stated in terms of how many of each unit must be sold:

Cost-Volume-Profit Analysis

Q3: Multiple Product Breakeven Point

Find the BEP in sales $ for Peggys Kitchen Wares. The total revenue and total variable cost information below is based on the expected sales mix.

Expected sales in units Total revenue Total variable costs Total contribution margin Contribution margin ratio

Small Medium 2,000 5,000

Large 3,000

Total 10,000

$20,000 $75,000 $54,000 $149,000 $8,000 $40,000 $33,000 $81,000 $12,000 $35,000 $21,000 $68,000 60.0% 46.7% 38.9% 45.6%

First compute the weighted average contribution margin ratio:

Chapter 3: Cost-Volume-Profit Analysis

Slide # 43

. . . = 45.6%, of course! Depending on how the given information is structured, it may be easier to compute the CMR as Total contribution margin/Total revenue.

Next compute the BEP in sales $:

* If you sum the number of units of each size pan required at breakeven times its selling price you get $89,400. The extra $74 in the answer above comes from rounding the contribution margin ratio to three decimals.

Margin of Safety
The margin of safety is a measure of how far past the breakeven point a company is operating, or plans to operate. It can be measured 3 ways. margin of safety in units margin of safety in $ margin of safety percentage

= =
=

actual or estimated units of activity BEP in units actual or estimated sales $ BEP in sales $
Margin of safety in units Actual or estimated units

Margin of safety in $ Actual or estimated sales $

Chapter 3: Cost-Volume-Profit Analysis

Slide # 45

Q6: Margin of Safety

Suppose that Bills Briefcases has budgeted next years sales at 5,000 units. Compute all three measures of the margin of safety for Bill. Recall that P = $200, V = $80, F = $360,000, the BEP in units = 3,000, and the BEP in sales $ = $600,000.

The margin of safety tells Bill how far sales can decrease before profits go to zero.

Degree of Operating Leverage The degree of operating leverage measures the extent to which the cost function is comprised of fixed costs.
A high degree of operating leverage indicates a high proportion of fixed costs. Businesses operating at a high degree of operating leverage
face higher risk of loss when sales decrease, but enjoy profits that rise more quickly when sales increase.
Chapter 3: Cost-Volume-Profit Analysis

Slide # 47

Degree of Operating Leverage The degree of operating leverage can be computed 3 ways.
Contribution margin Profit

degree of operating leverage

1 Margin of safety percentage

Fixed costs +1 Profit

Chapter 3: Cost-Volume-Profit Analysis

Slide # 48

Degree of Operating Leverage

Suppose that Bills Briefcases has budgeted next years sales at 5,000 units. Compute Bills degree of operating leverage. Recall that P = $200, V = $80, F = $360,000, and the margin of safety percentage at 5,000 units is 40%.

First, compute contribution margin and profit at 5,000 units:

Using the Degree of Operating Leverage The degree of operating leverage shows the sensitivity of profits to changes in sales.
On the prior slide Bills degree of operating leverage was 2.5 and profits were $240,000.
If expected sales were to increase to 6,000 units, a 20% increase, then profits would increase by 2.5 x 20%, or 50%, to $360,000.* If expected sales were to decrease to 4,500 units, a 10% decrease, then profits would decrease by 2.5 x 10%, or 25%, to $180,000.**
Chapter 3: Cost-Volume-Profit Analysis

Slide # 50

Relevant Question
SXF Corporation sells its single product for $14 per unit, and its variable cost per unit is $4. Total fixed costs are $800. Its CVP graph is as follows:
4500 4000 3500 3000 2500 2000 1500 1000 500 0 0 50 100 150 200 250 300 350
Slide # 51

Point A
Point B

Area C

Area D

Actual volume

Chapter 3: Cost-Volume-Profit Analysis

15. a. b. c. d. 16. a. b. c. d.

Point A is best described as Fixed cost Margin of safety Estimated profit at actual volume Breakeven point Area C is best described as Fixed cost Margin of safety Estimated profit at actual volume Breakeven point

17. Smith Co. has a contribution margin ratio of 40% and a breakeven point of $200,000 in sales. If the firm reports net income of $50,000 after taxes of 50%, what were total sales for the year? a. $450,000 b. $466,667 c. $500,000 d. $700,000

If fixed costs are $100,000, unit sales price is $12, unit variable cost is $4, and the desired after-tax profit is $48,000, what are the required sales Ans $240,000

ZTL Corporation produces three products. Cost, price, and volume data is shown below: Total Fixed costs $2,400 Tax rate 40%
Picture holders Candle Holders CD Holders

Normal volume Price per unit Variable cost per unit

300 $5 2

150 $7 3

200 $10 4

18. The weighted average contribution margin ratio, rounded to the nearest whole percent, is a. 57% b. 59% c. 60% d. Some other number

21. Ryan Company manufactures a single product. The product sells for $10. The variable manufacturing cost per unit is $2 and the variable selling cost is $2 per unit. Ryan incurs monthly fixed costs of $100,000 for manufacturing and $140,000 for administration and selling. Ryan is considering changes to its production and distribution procedures. If the changes are made, total variable costs (manufacturing and selling) will be $3 and total fixed costs (manufacturing, administration, and selling) will be $350,000 per month. The selling price will remain at $10. If the changes are made, the number of units required to break even will be a. Greater than before b. The same as before c. Less than before d. Cannot be determined

20. Nunn Company produces a single product. Following is cost information: Manufacturing costs Non-manufacturing costs Fixed Cost $35,000 60,000 variable cost Per unit $15 10

If the product sells for $60, how many units must be sold to break

even?
a. b. c. d. 1,000 2,375 2,714 3,800

19. A firm with fixed costs of $61,500 per month sells three products with the following characteristics: Sales Mix Contribution Product PercentageMargin P 25% $48 Q 50% 50 R 25% 52 How many total units must be sold to breakeven? a. 1,230 b. 1,500 c. 1,533 d. 1,600

Multiproduct Cost-Volume-Profit Analysis

Assumes a constant product sales mix Contribution margin is weighted on the quantities of each product included in the bag of products Contribution margin of the product making up the largest proportion of the bag has the greatest impact on the average contribution margin of the product mix

Alpha Associates has the following details:

Fixed cost = Rs. 20,00,000 Variable cost per unit = Rs. 100 Selling price per unit = Rs. 200 Find (a) The break-even sales quantity (b) The break-even sales (c) If the actual production quantity is 60,000, find (i) contribution; and (ii) margin of safety by all methods. Answer:- 20,000 units , Rs. 40,00,000 , Rs. 60,00,000

Consider the following data of a company for the year 1998: Sales = Rs. 80,000 Fixed cost = Rs. 15,000 Variable cost = Rs. 35,000 Find the following:

(a) (b) (c) (d)

Contribution Profit BEP M.S.

Answer:- Rs. 45,000 , 56.25% , Rs. 26,667 , Rs. 53,333.33

THANKS !