BREAK EVEN ANALYSIS Break-even point refers to a level of sales or output at which the total revenue equals total

l cost and the net income is equal to zero. In other words, at the break-even point the firm neither gets profit nor does it suffer any loss. The BEA is an important technique to trace the relationship between cost, revenue and profit at varying levels of output or sales. ASSUMPTIONS 1. The cost and revenue functions are linear. 2. The total cost includes fixed costs and the variable costs. 3. The selling price remains the same. 4. The volume of sales and output are identical. 5. Average and marginal productivity of the factors remains constant. 6. Factor price remains the same. 7. The product-mix is stable in case of a multiproduct firm. (1)

1. BEP in terms of Physical Units (Qb) Total Fixed Cost BEP or Qb = --------------------------Contribution Margin TFC Qb = ------------SP AVC Example 1: Total costs of a firm are Rs.20000 per annum, variable cost per unit is Rs.4 and selling price is Rs.8 per unit. The firm has the capacity to produce 10000 units. Find out BEP or Qb (Sales Volume). TFC 20000 Qb = ------------- = ---------- = 5000 Units. SP AVC 84 Proof: TR = 5000 8 = Rs.40000 TC = TFC + AVC Q = 20000+ 4 5,000 = Rs40000. At BEP TR = TC (2)

2. BEP in Terms of Sales Value (Sb) TFC Sb = -----------------1 (AVC / P) In example1, find out the sales value. 20000 20000 Sb = --------------- = ----------- = Rs.40000. 1 (AVC/ P) 1 1/ 2 3. BEP as Percentage of full capacity TFC 100 % B = ------------------------ (SP AVC) Qmax In Example1 20000 100 %B = --------------------- (8 4) x 10000 2000000 = ----------------- = 50 % 40000 4. Volume needed to attain Target Profit TFC + TP TSV = --------------P AVC (3)

In example1, if the targeted profit is Rs.12000, the target sales volume will be estimated as follows: 20000 + 12000 TSV = -------------------84 = 32000 / 4 = 8000 units. 5. Safety Margin Margin of safety refers to the extent to which a firm can afford a decline in sale before it starts incurring losses. (Sales BEP) 100 Safety Margin = ------------------- Sales Suppose in example 1 sales of the firm are 8000 units, then the safety margin can be estimated as follows: (8000 5000) 100 SM = -------------------- 8000 = 37.5 %. (4)

6. Change in Price In case the firm decides to reduce the price, the new sales volume to attain the same profit (Rs.12000) can be estimated as follows: TFC + Profit Qn = -------------------SPn AVC Where Qn = New sales volume SPn = New selling price ( a ) Suppose the firm decides to reduce the price by 10 % to maintain target profit of Rs12000, the Qn will be estimated as follows: The new price is (8 0.8) = Rs.7.2 20000 12000 Qn = ------------------7.2 4 = 32000 / 3.2 = 10000 units. ( b ) Suppose the firm decides to increase the price by 12.5 %, then the new price will be (8 + 1) = Rs.9. (5)

20000 + 12000 Qn = -------------------- = 6400 units. 94 Conclusion: ( i ) If the firm decides to reduce the price, it will have to sell larger quantity to maintain target profit. ( ii ) If the firm decides to increase the price, it will have to sell smaller quantity to maintain target profit. 7. Changes in Costs ( a ) Change in variable costs to determine ( i ) New Quantity (Qn) TFC + Profit Qn = ----------------Price AVCn In example 1 if the variable cost is raised to Rs.5, the Qn will be estimated as follows: 20000 + 12000 32000 Qn = ------------------ = -------- =10667 units. 85 3 (6) ( ii ) New Selling Price (SPn) (7)

SPn = SP + (AVCn AVC) = 8 + (5 4 ) = 8 + 1 = 9. ( b ) Change in the Fixed Costs to determine ( i ) New Quantity (Qn) TFCn TFC Qn = Q + ----------------SP - AVC In example 1, if TFC is raised to Rs.30000 for selling 8000 units and to get target profit of Rs.12000. 30000 20000 Qn = 8000 + --------------------84 = 8000 +2500 = 10500 units. ( ii ) New Selling Price (SPn) TFCn TFC SPn = SP + -----------------Q 30000 20000 = 8 + ------------------- = Rs.9.25. 8000