BREAK-EVEN ANALYSIS: (COST-VOLUME-PROFIT ANALYSIS):

The break-even analysis (BEA) also known as Cost-Volume-Profit (CVP) analysis has
considerable significance for economic research, business decision-making, investment
analysis etc. This technique traces relationship between costs, revenue and profit at varying
levels of output. In BEA, the break-even point (BEP) is located at the level of output at which
the net income or profit is zero. At this point, total cost is equal to the total revenue. Hence,
BEP is the no-profit-no-loss point.
Definition of Break Even point:
Breakeven point is the level of sales at which profit is zero. According to this definition, at
breakeven point sales are equal to fixed cost plus variable cost. This concept is further
explained by the following equation:
[Break even sales = fixed cost + variable cost]
Cost-Volume-Profit (C-V-P) Relationship:
In marginal costing, marginal cost varies directly with the volume of production or output.
On the other hand, fixed cost remains unaltered regardless of the volume of output. If volume
is changed, variable cost varies as per the change in volume. Apart from profit projection, the
concept of C-V-P is relevant to virtually all decision-making areas, particularly in the short
run.
The relationship among cost, revenue and profit at different levels may be expressed in
graphs such as breakeven charts, profit volume graphs, or in various statement forms. Profit
depends on a large number of factors, most important of which are the cost of manufacturing
and the volume of sales. Both these factors are interdependent. Volume of sales depends upon
the volume of production and market forces which in turn is related to costs. Management has
no control over market. In order to achieve certain level of profitability, it has to exercise
control and management of costs, mainly variable cost. This is because fixed cost, a noncontrollable cost is dependent on such factors as Volume of production, Product mix,
Productivity of the factors of production, Technology, Size of plant etc.
Thus, the cost-volume-profit analysis furnishes the complete picture of the profit structure.
This enables management to distinguish among the effect of sales, fluctuations in volume and
the results of changes in price of product/services.
ASSUMPTIONS OF BREAKEVEN ANALYSIS:
1. Costs can be reasonably subdivided into fixed and variable components.
2. All cost-volume-profit relationships are linear.
3. Sales prices will not change with changes in volume.
4. Costs can be reasonably subdivided into fixed and variable components.
5. The analysis either covers a single product or assumes that the sales mix sold in case
of multiple products will remain constant as the level of total units sold changes.

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Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

BREAKEVEN APPLICATIONS
Four major applications:
1. New product decisions: Determine sales volume required for firm (or
individual product) to break even, given expected sales and expected costs
2. Pricing decisions: Study the effect of changing price and volume
relationships on total profits
3. Modernization or automation decisions: Analyze profit implications of a
modernization or automation program. In this case, firm substitutes fixed costs
(i.e. capital equipment costs) for variable costs (i.e. direct labor)
4. Expansion decisions: Study aggregate effect of general expansion in
production and sales. In this case, relationships between total dollar dales for
all products and total dollar costs for all products are examined in order to
identify potential changes in these relationships
LIMITATIONS OF BREAK EVEN ANALYSIS:
Selling costs are especially difficult to handle in break-even analysis. This is
because the changes in selling costs are a cause and not a result of changes in
output and sales.
Costs in a particular period may not be caused entirely by the output in that
period. For example, maintenance expenses may be the result of past output
Break-even analysis assumes that profits are a function of output ignoring the
fact that they are also caused by other factors such as technological change,
improved management, changes in the scale of the fixed factors of
production, etc.
A basic assumption in break-even analysis is that the cost-revenue-volume
relationship is linear. This is realistic only over narrow ranges of output
Break-even analysis is not an effective tool for long-range use and its use
should be restricted to the short run only.
The Break-Even Chart
In its simplest form, the break-even chart is a graphical representation of costs at various
levels of activity shown on the same chart as the variation of income (or sales, revenue) with
the same variation in activity. The point at which neither profit nor loss is made is known as
the "break-even point" and is represented on the chart below by the intersection of the two
lines:

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Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

In the diagram above, the line OA represents the variation of income at varying levels of
production activity ("output"). OB represents the total fixed costs in the business. As output
increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase.
At low levels of output, Costs are greater than Income. At the point of intersection, P, costs
are exactly equal to income, and hence neither profit nor loss is made.
Marginal Cost Equations and Breakeven Analysis:
Sales Marginal cost = Fixed cost + Profit = Contribution
1. Contribution
Contribution is the difference between sales and marginal or variable costs. It contributes
toward fixed cost and profit. The concept of contribution helps in deciding breakeven point,
profitability of products, departments etc.
2. Profit Volume Ratio (P/V Ratio), its Improvement and Application
The ratio of contribution to sales is P/V ratio. It is the contribution per rupee of sales and
since the fixed cost remains constant in short-run, P/V ratio will also measure the rate of
change of profit due to change in volume of sales. The P/V ratio may be expressed as
follows:
P/V Ratio =

Contribution =

Change in Contribution =

Change in Profit

Sales

Change in Sales

Change in Sales

A fundamental property of marginal costing system is that P/V ratio remains constant at
different levels of activity. A change in fixed cost does not affect P/V ratio.
3. Breakeven Point
Breakeven point is the volume of sales or production where there is neither profit nor loss.
S (sales) V (variable cost) = F (fixed cost) + P (profit)
At BEP P = 0
Thus, Break-even point in quantity (BEP) = F / (S -V)
cost)
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= Fixed cost / (Sales Variable

Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

= Fixed cost / Contribution per unit =TFC/SP-AVC

BEP in sales=TFC/SP-AVC*SP
Break-even Sales =

Fixed cost
P/V Ratio

4. Margin of Safety (MOS)

Margin of safety is calculated as the difference between the total sales (actual or projected)
and the breakeven sales. It may be expressed in monetary terms (value) or as a number of
units (volume). A large margin of safety indicates the soundness and financial strength of
business. Margin of safety can be improved by lowering fixed and variable costs, increasing
volume of sales or selling price and changing product mix.

Sales at selected activity Sales at BEP = TOTAL SALES SALES

=
Profit

Margin of safety =
AT BEP

P/V Ratio

Managerial Uses of Break-even Analysis

Break-even analysis not only highlights the areas of economic strength and weaknesses in the
firm but also sharpens the focus on certain leverages which can be operated upon to enhance
its profitability. Through break-even analysis, it is possible to devise managerial actions to
enhance profitability of the firm. The break-even analysis can be used for the following
purposes:
Safety Margin: The break-even chart can help the manager to get a fast idea about
the profits generated at the various levels of sales. But while deciding upon the
volume at which the firm would operate, apart from the demand, manager should
consider the Safety Margin associated with the proposed volume. The safety margin
refers to the extent to which the firm can afford a decline in sales before it starts
incurring losses. If the safety margin is dropping over a period of time, it would mean
that the firms resistance capacity to avoid losses has become poorer. A margin of
safety can be negative as well. In that case, it reveals the percentage increase in sales
necessary to reach the BEP so as at least to avoid losses.
Volume Needed to Attain Target Profit: Break-even analysis may be utilized for
the purpose of determining the volume of sales necessary to achieve a target profit.

Target sales volume =

Fixed cos t T arg etprofit

Contributi on m arg in unit

Change in Price: The manager is often faced with a problem of whether to reduce
price or not. Before deciding on this question the manager must consider a number of
points. A reduction in price leads to a reduction in the contribution margin. This
means that the volume of sales will have to be increased to maintain the previous
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Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

level of profit. The higher the reduction in the contribution margin, the higher is the
increase in sales needed to ensure the previous profit. However, reduction in price
may not always lead to a proportionate increase in the volume of sales. Assuming that
the present conditions continue, break-even analysis will help the manager to know
the required volume of sales to maintain the previous level of profit. And on the basis
of its knowledge and experience, it will be much easier for the management to judge
whether the required increase in sales will be feasible. The formula for determining
the new volume of sales to maintain the same profit, given a reduction in price, is:

New volume of sales =

Fixed cost + Profit______

Variable cost New Selling price

Change in Costs:
o If Variable Costs Change
o An increase in variable costs leads to a reduction in the contribution margin.
Therefore, when increases in costs are expected or is unavoidable, a common
question which arises is what total sales volume we need to maintain our
present profits without any increase in price or, in the alternative, what price
should be fixed for the product to maintain our present profit without any
change in sales volume. The formula to determine the new quantity (Q n) when
there is a change in variable costs is:

New quantity =

Fixed cost + Profit______

New selling price Variable cost

If Fixed Costs Change

o An increase in fixed costs of a firm may be caused either by external
circumstances (e.g., an increase in machinery costs, taxes, etc) or by a
managerial decision (e.g., an increase in salaries). Then a question arises on
what total sales volume do we need to maintain to have our present profits
without any increase in price or in the alternative, what price should be set if
there is no change in sales volume? The formula to determine the new quantity
(Q n) or the new price (SP n3) given a change in fixed costs would be:

Qn Q

FC n FC
SP VC

Problem:
A company producing a single article sells it at Rs. 10 each. The marginal cost of production
is Rs. 6 each and fixed cost is Rs. 400 per annum. You are required to calculate the
following:

P/V ratio
Breakeven sales
Sales to earn a profit of Rs. 500
Profit at sales of Rs. 3,000
New breakeven point if sales price is reduced by 10%

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Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

 Margin of safety at sales of 400 units

Particulars
Amount

Amount

Amount

Amount

Units produced

50

100

400

Sales (units * 10)

10

500

1000

4000

Variable cost

300

600

2400

Contribution (sales- VC)

200

400

1600

Fixed cost

400

400

400

400

P/V Ratio = (Contribution / Sales) x 100 = 0.4 or 40%

Breakeven sales (Rs.) = Fixed cost / (P/V Ratio) = 400/ 0.4 = Rs. 1,000
Sales at BEP = Contribution at BEP/ (P/V Ratio) = 100 units

Contribution at profit Rs. 500 = Fixed cost + Profit = Rs. 900

Sales to earn a profit of Rs. 500 = Contribution / (P/V Ratio) = 900/.4 = Rs. 2,250 (or 225
units)
Contribution at sales Rs. 3,000 = Sales x P/V Ratio = 3000 x 0.4 = Rs. 1,200
Profit at sales of Rs. 3,000 = Contribution Fixed cost = Rs. 1200 Rs. 400 = Rs. 800
New P/V ratio when sales price is reduced by 10% = Rs. 9 Rs. 6 / Rs. 9 = 1/3
Sales at BEP = Fixed cost/PV ratio = Rs. 400 / (1/3) = Rs. 1200
Margin of safety (at 400 units) = (4000 1000) / 4000 x 100 = 75 %
(Actual sales BEP sales/Actual sales x 100)
Problem:
The sales and profits during two years are as follows:
Year

Sales

Profit

2006

1, 00,000

15,000

2007

1, 20,000

23,000

You are required to find out:

a)
b)
c)
d)

P/V ratio
Fixed cost
Profit at an estimated sales of Rs. 1, 25,000
Sales required to earn a profit of Rs. 20,000

Solution:
a)

P/V ratio =

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Change in profit x 100 =

8,000 x 100

= 40%

Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

Change in sales
b)

20,000

Since contribution is 40% of sales, Variable cost = 60% of sales = Rs. 60,000
Fixed cost = 1, 00,000 60,000 15,000 = Rs. 25,000

c)

Contribution, when sales is Rs. 1, 25,000 = 1, 25,000 x 0.4 = Rs. 50,000

Profit = 50,000 25,000 = Rs. 25,000

d)
Sales required to earn a profit of Rs. 20,000 = (Fixed cost + Desired profit) / (P/V
ratio)
= (25,000 + 20,000) / 0.40 = Rs. 1, 12,500
Example:
A furniture manufacture produces and sells the cabinets, office tables and chairs. The various
details regarding his business are given below:
Product

Selling price per

unit Rs.

Variable cost per

unit Rs.

% of rupee sales
volume

File cabinet

1000

900

20

Office tables

500

400

30

Chairs

200

125

50

Capacity of the firm = Rs 1, 50, 000 of total sale volume

Annual fixed cost

= Rs 20, 000

Calculate
1) S BEP and 2) Profit if firm works at 80% of capacity
Solution:
The contribution towards fixed cost in each case is
a)
b)
c)

File cabinet - Rs 1000 - Rs 900

Office tables - Rs 500 - Rs 400
Chairs
- Rs 200 - Rs 125

= Rs 100
= Rs 100
= Rs 75

Now there contributions are to be converted into percentages of sell prices and the formula is
contribution percentage

Selling Pr ice Variable Cost

x 100
Selling Pr ice

Therefore, the contribution percentage for individual items is

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Assist. Prof. Sachidananda Sahoo, IIIT, BBSR

File cabinet

100 900
100
x 100
x 100 10%
1000
1000

Office tables
Chairs

500 400
100
x 100
x 100 20%
500
500

200 125
75
x 100
x 100 37.5%
200
200

To get the total contribution per rupee sales volume for the file cabinet, office tables and
chairs, we multiply the contribution percentage of each of the products by the percentage of
sales volume for that particular product and add the figures so obtained.
Furniture (a)

Contribution % (b)

% of sales in Rs (c)

b x c/100

File cabinet

10

20

2000/100=2.00

Office tables

20

30

600/100 = 6.00

Chairs

37.5

50

1875/100=18.7
26.75 or 27%

27% is the total contribution per rupee of overall sales given the present product sales mix.
1) BEP

Fixed Costs
20000 20000

x100 Rs. 74074

Contributi on M arg in ratio
27%
27

2) Profit = Total revenue Total costs

Here Total revenue = 80% of the total capacity of the firm (given data in the problem)
Therefore, Profit
= 80% of Rs 1, 50, 000 - (Total fixed cost + Total variable cost)
= 1, 20, 000 - (20,000 + 73% of 1, 20, 000)
= Rs 12, 400

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Assist. Prof. Sachidananda Sahoo, IIIT, BBSR