MANAGEMENT ACCOUNTING

Breakeven Analysis

INTRODUCTIONIt is very important for a company to work out whether or not they are making a profit.We can work out by writing up a Trading , profit and loss account.It is often useful to be able to predict profit or loss in the future.We can ascertain this using break even analysis.

Break-even Analysis Defined It is a widely used technique to study cost volume price relationship. It is interpreted as narrow as well as broad sense.

Narrow : the level of production and sales where there is no profit and no loss at the point where total cost = total sales revenue.

Broad: it is used to determine probable profit & loss at any given level of production/sales.

It also helps to determine the amount or volume of sales to earn a desired amount or profit.

Assumptions underlying Breakeven Analysis11-4

All costs are separated into fixed costs & Variable components.

Variable costs per unit remains constant & total variable cost varies in direct proportion to the volume of production.

Fixed cost remain constant S.P per unit does not change as volume

changes. There is only one product or incase of

multiple products the mix does not change. Productivity per worker does not change.

Uses of Breakeven Analysis Determining the break even point Determining the selling price which will give the desire

profit. Determining the sales volume to earn a desire profit or

return on capital employed. It helps in determining the most profitable sales mix. It helps in management decision making It helps in determining cash requirement at different levels

of operation.

It may be performed by two method.

algebraic method: graphical representation(break-even chart).

Methods of Breakeven Analysis

Breakeven Analysis Key Terminology

Break even point- it is the point at which a company makes neither a profit nor a loss.

Contribution per unit- the sales price minus the variable cost per unit. It measures the contribution made by each item of output to the fixed costs and profit of the organisation.

Margin of safety- It is defined as the difference between actual sales and sales at break even point. size of margin of safety indicates soundness of a business.

Marginal Cost – it is composed of all direct costs & variable overheads.

Breakeven Formula Contribution per unit = Selling Price per unit –

Variable Cost per unit.

Break even point(in units)=(Total fixed cost)/contribution per unit

F/S-V

Example of Algebraic method

Using the following data, calculate the

breakeven point and margin of safety in units:

Selling Price = Rs50 Variable Cost = Rs40 Fixed Cost = Rs 70,000 Budgeted Sales = 7,500 units

Solution Contribution = 50 - 40 = 10 per unit Breakeven point = 70,000/10 = 7,000

units Margin of safety = 7500 – 7000 = 500

units

Graphical Representation-Breakeven Chart

Limitations of B/E analysis Assumption that all costs can be clearly separated into

fixed and variable components is not possible in actual practice.

Assumption that variable cost per unit remains constant and it gives a straight line is not always true.

Fixed costs also remains constant is also unrealistic. it is constant only with limited range of output.

Assumption regarding Selling price remains constant as volume changes is also not true.

Breakeven analysis completely ignores the consideration of capital employed which may be an important factor.

Conclusion

Break-even analysis is a powerful tool you can use to

determine whether your business idea will be profitable.

Even if this analysis shows that you can make a profit

given your expected sales and costs.