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Vivekananda College Thakurpukur KOLKATA-700063: Naac Accredited A' Grade

The document is about break-even analysis, which is a technique used to determine the sales volume needed to cover total costs. It defines break-even point as the level of output where total revenue equals total costs. The document then provides a graphical representation of the break-even model and discusses the assumptions of break-even analysis. It also describes the algebraic and graphical methods for calculating break-even point, break-even sales, margin of safety, contribution margin, and profit-volume ratio. Finally, it outlines the uses and limitations of break-even analysis.

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Paramartha Banerjee
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83 views8 pages

Vivekananda College Thakurpukur KOLKATA-700063: Naac Accredited A' Grade

The document is about break-even analysis, which is a technique used to determine the sales volume needed to cover total costs. It defines break-even point as the level of output where total revenue equals total costs. The document then provides a graphical representation of the break-even model and discusses the assumptions of break-even analysis. It also describes the algebraic and graphical methods for calculating break-even point, break-even sales, margin of safety, contribution margin, and profit-volume ratio. Finally, it outlines the uses and limitations of break-even analysis.

Uploaded by

Paramartha Banerjee
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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VIVEKANANDA COLLEGE

THAKURPUKUR
KOLKATA-700063
NAAC ACCREDITED ‘A’ GRADE

Topic: Break-Even Analysis


Course Title: Skill Enhancement course II (Managerial Economics)
Paper: ECO-A-SEC-4-B(2)-TH
Unit: 1
Semester: Semester IV
Name of the Teacher: Pawan Subba
Name of the Department: Economics
Break-Even Analysis

Break-even point is the level of output at which the total revenue (TR)
is equal to the total cost (TC).
TR = TC (at break-even point).
A profit-maximising firm’s initial objective is to cover up all its costs
and reach the break-even point, and subsequently make profit
thereafter.
Graphical representation of Break-even model.

In the figure above, the horizontal axis measures the rate of


output and the vertical axis measures the total revenue and total
costs. The TR curve is inverted U- shaped and TC curve is S-shaped.
The inverted U shape of TR curve is because of the assumption
that the firm faces a downward-sloping demand curve and must
reduce its price to be able to sell more output. Whereas, the TC curve
is S-shaped due to law of diminishing returns.
The vertical distance between the TR and TC curve measures the
profit or loss associated with a given level of output. To the left of Q A
and to the right of QB, TC exceeds TR and represents loss.
In the figure there are two break-even points B and B’ at which
TR= TC. In between B and B’, TR> TC and hence shows positive profits.
At output level Qc, the profit level is maximum as the vertical distance
between TR and TC is largest.

Assumptions of Break-even analysis:-


In order to simplify the process of computing the following
assumptions are taken into consideration.
(i) The total fixed costs (TFC) remains constant at all the output levels.
(ii) The sales price per unit is constant throughout the output levels.
(iii) The TR and TC curve is considered to be linear (i.e. MR and MC is
constant).
(iv)The inventory remains constant at the start and the end of the
accounting period.
(v) The other factors such as efficiency, production and technology do
not change.
(1)Graphical Method:-

The vertical distance between TC and TFC line equals the


TVC. As the quantity of output increases, the vertical distance
between TC and TFC also increases. This implies that TVC increases
with an increase in TC.
At the production level below QB, the total cost exceeds
the total revenue. It implies that a firm will suffer losses if it produces
output less than QB. At QB output level, the total revenue is equal to
the total cost. At this point the firm neither makes profit nor makes
loss, implying that it is a break-even point. Thus, QB is a break-even
level of output. If the firm produces more than Q B level of output, it
will be profitable for the firm as the total revenue will be greater than
total cost.

(2) Algebraic Method:-


(I) Break-Even Quantity:-
In a linear Cost-Volume-Profit analysis model (where
marginal cost and marginal revenues are constant), the break-even
point (BEP) can be directly computed in terms of Total Revenue (TR)
and Total Costs (TC).
TR = TC
 P * QB = TFC + TVC ; QB = Break-even quantity.
 P * QB = TFC + AVC * QB
 ( P – AVC) *QB = TFC
 QB = TFC/( P – AVC)

(II) Break-Even Sales (SB):-


Multiplying the above equation by ‘P’ we get;
P * Q = P * [TFC/ (P – AVC)]
 SB = TFC /[1 – (AVC/P)]

(III) Break-Even point in terms of percentage utilisation of plant


capacity (%B):-
%B = (QB/QCAP) * 100; QCAP = maximum capacity of the plant output)
 %B = [TFC/(( P – AVC)* QCAP)] * 100
Total Contribution Margin:-
In the short-run, a firm’s initial objective is to cover
variable cost. If this cannot be covered, it would prefer to close down
its operations. If the price of the product exceeds the variable cost,
the firm would attempt to expand production with a view to cover its
fixed cost and make profits, thereafter. Hence, output will expand if
price (P) exceeds average variable cost (i.e. if P > AVC). The difference
between the price and AVC is called the contribution margin per unit
or average contribution margin (ACM). If the average contribution
margin at a particular price point is excessively low or negative, it
would be unwise to continue selling a product at that price.
Therefore, ACM = P – AVC
 ACM * Q = (P – AVC) * Q (multiplying by Q on both sides
of the equation).
 TCM = PQ – TVC
 TCM = TR – TVC
Therefore,
Total Contribution Margin = Total Revenue – Total Variable Cost.
Again, Total Net Profit (TNP) = Total Revenue (TR) – Total Cost (TC)
= TR – (TFC + TVC)
= TR – TFC –TVC
 TNP + TFC = TR – TVC
Therefore, TCM = TR – TVC = TNP + TFC
& ACM =P – AVC = ANP + AFC
Profit- Volume ratio:-
Marginal Income ratio or Profit – Volume ratio is the
percentage of the sales which is available as a contribution to fixed
costs and profits after direct costs are deducted.
Therefore,
P-V ratio = (TCM/Sales)*100
 P-V ratio = [(TNP+ TFC)/Sales]*100

Margin of Safety:-
In break-even analysis, margin of safety is the extent by
which the actual or projected sales exceed the break-even sales. In
other words, all sales revenue that a company collects over and above
its break-even point represents the margin of safety.
MOS = π / TFC
 MOS = (Qs – QB)/Qs
The larger the ratio of profits to total fixed costs, the
better it is for the firm from the stand point of safety.

Uses of Break- Even Analysis:-


• Helps in determining the sales volume.
• Forecasts profits if estimates of revenue and cost are available.
• Helps in appraising the effects of change on volume of sales and
cost of production.
• Assists in making choice of products and determining the
product mix.
• Highlights the impact of increase or decrease in the fixed and
variable costs.
Limitations of Break-Even Analysis:-
• It fails to be applied effectively in the multiple products
situation.
• It fails to be implemented in the situation where cost and
price cannot be ascertained and where historical data is
not available.
• It assumes fixed cost to be constant.
• It assumes that quantity of goods produced is equal to
the quantity of goods sold, which may not be always true.
• It ignores the changes in selling prices.
• It ignores the market conditions.

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