1.

BREAK-EVEN POINT

The break-even point for a product is the point where total revenue
received equals the total costs associated with the sale of the product
(TR=TC).
A break-even point is typically calculated in order for businesses to
determine if it would be profitable to sell a proposed product, as opposed to
attempting to modify an existing product instead so it can be made
lucrative. Break even analysis can also be used to analyse the potential
profitability of an expenditure in a sales-based business.
break even point (for output) = fixed cost / contribution per unit
contribution (p.u) = selling price (p.u) - variable cost (p.u)
Review Problem:
Voltar Company manufactures and sells a telephone answering machine.
The company's contribution format income statement for the most recent
year is given below:
Per
Total Percent of sales
unit
$1,200
Sales $60 100%
,000
900,00
Less variable expenses 45 ?%
0
---------- --------
---------------
----- -------
300,00
Contribution margin 15 ?%
0
240,00 ===
Less fixed expenses ======
0 ===
----------
-----
$60,00
Net operating income
0
====
==
Calculate break even point both in units and sales dollars. Use the equation
method.
Solution:
Sales = Variable expenses + Fixed expenses +Profit

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 $60Q = $45Q + $240,000 + $0
$15Q = $240,000
Q = $240,000 / 15 per unit
Q = 16,000 units; or at $60 per unit, $960,000
Alternative solution:
X = 0.75X + 240,000 + $0
0.25X = $240,000
X = $240,000 / 0.25
X = $960,000; or at $60 per unit, 16,000 units
2. CONTRIBUTION MARGIN

The contribution margin method is actually just a short cut conversion of the
equation method already described. The approach centers on the idea
discussed earlier that each unit sold provides a certain amount of
contribution margin that goes toward covering fixed cost. To find out how
many units must be sold to break even, divide the total fixed cost by the unit
contribution margin..
The Total Contribution Margin (TCM) is Total Revenue (TR, or Sales) minus
Total Variable Cost (TVC):
TCM = TR − TVC

The Unit Contribution Margin (C) is Unit Revenue (Price, P) minus Unit
Variable Cost (V):
C=P−V

The Contribution Margin Ratio is the percentage of Contribution over Total

Revenue, which can be calculated from the unit contribution over unit price
or total contribution over Total Revenue:

For instance, if the price is $10 and the unit variable cost is $2, then the unit
contribution margin is $8, and the contribution margin ratio is $8/$10 = 80%

3. VARIABLE COST AND FIXED COST

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All the costs faced by companies can be broken into two main categories:
fixed costs and variable costs.
Fixed costs are costs that are independent of output. These remain
constant throughout the relevant range and are usually considered sunk for
the relevant range (not relevant to output decisions). Fixed costs often
include rent, buildings, machinery, etc.
Variable costs are costs that vary with output. Generally variable costs
increase at a constant rate relative to labor and capital. Variable costs may
include wages, utilities, materials used in production, etc.
In accounting they also often refer to mixed costs. These are simply costs
that are part fixed and part variable. An example could be electricity--
electricity usage may increase with production but if nothing is produced a
factory still may require a certain amount of power just to maintain itself.
Below is an example of a firm's cost schedule and a graph of the fixed and
variable costs. Noticed that the fixed cost curve is flat and the variable cost
curve has a constant upward slope.

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MARGIN OF SAFETY(MOS)

Margin of safety (MOS) is the excess of budgeted or actual sales over the
break even volume of sales. It stats the amount by which sales can drop
before losses begin to be incurred. The higher the margin of safety, the
lower the risk of not breaking even.
Formula of Margin of Safety
The formula or equation for the calculation of margin of safety is as follows:
[Margin of Safety = Total budgeted or actual sales − Break even
sales]
The margin of safety can also be expressed in percentage form. This
percentage is obtained by dividing the margin of safety in dollar terms by
total sales. Following equation is used for this purpose.
[Margin of Safety = Margin of safety in dollars / Total budgeted or
actual sales]
Example:
Sales(400 units @ $250) $100,00
0

Break even sales $87,500

Calculate margin of safety

Calculation:
Sales(400units @$250) $100,00
0

Break even sales $

87,500

-----------
--

Margin of safety in dollars $

12,500

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 =====
==

Margin of safety as a percentage of

sales:
12,500 / 100,000
= 12.5%

It means that at the current level of sales and with the company's current
prices and cost structure, a reduction in sales of $12,500, or 12.5%, would
result in just breaking even. In a single product firm, the margin of safety
can also be expressed in terms of the number of units sold by dividing the
margin of safety in dollars by the selling price per unit. In this case, the
margin of safety is 50 units ($12,500 ÷ $ 250 units = 50 units).
Review Problem:
Voltar company manufactures and sells a telephone answering machine. The
company's contribution margin income statement for the most recent year is
given below:
Percen
Per
Description Total t of
unit
Sales

$
Sales (20,000
1,200,00 $60 100%
units)
0

Less variable
900,000 $45 ?%
expenses

---------- --------- ---------

Contribution
300,000 $15 ?%
margin

Less fixed =====

240,000 =====
expenses =

----------

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 Net operating
income 60,000

====
==

Required: Calculate margin of safety both in dollars and percentage form.

Solution to Review Problem:

Margin of safety = Total sales – Break

even sales*
= $1,200,000 – $960,000
= $240,000
Margin of safety percentage = Margin
of safety in dollars / Total sales
= $240,000 / $1,200,000
= 20%
*The break even sales have been calculated
as follows:
Sales = Variable expenses + Fixed
expenses + Profit
$60Q = $45Q + $240,000 + $0**
$15Q = $240,000
Q = $240,000 / $15 per unit
Q = 16,000 units; or at $60 per unit.
$960,000

GRAPHICAL PRESENTATION OF BREAKEVEN

Break-even analysis is used to determine the impact of price and cost

strategies on firm's ability to remain solvent in the coming year without
excessive risk. The analytical procedure is short run, i.e. a time framework

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within which a firm does not consider changing its methods of production.
This very popular method consists in calculating the volume of sales for
which profits are null, that is, the point where the dollar amount of
contribution margin is just equal to total fixed costs

To calculate the break-even point of a firm, it is first necessary to sort out

costs:
1- UVC = unit variable costs are those that change with the volume of
production, such as raw materials and production costs included in costs of
goods sold, as well as selling, freight, and other costs that increase as
volume increases;
2- FC = fixed costs are those that are unavoidable, such as rent, staff and
executive salary, insurance, depreciation, general and administrative
expenses.
Some costs have both, a fixed and a variable portion, such as cost of utilities
or advertising. They must be separated in their constituent parts.
The break-even point is that quantity Q* for which
Q* = FC / (P - UVC)
where Q* = break-even volume
FC = fixed costs
P = unit price
UVC = unit variable cost
(P-UVC) = contribution margin
The formula is obtained by setting total revenue equal total cost (i.e. profits
are zero)
Q x P = Q x UVC + FC
and solving for Q.

Table 9.1 presents a hypothetical example of sales and profit illustrating

break-even analysis. The unit price is $5 and unit variable cost is $3. The
fixed cost is $300.
Table T-9.1
Break-even example
1 1 1 1 1 1 11
10 11
Units sold 2 3 4 5 6 7 8 9 200
0 0
0 0 0 0 0 0 00
6 6 7 7 8 8 99
Total 50 55
0 5 0 5 0 5 0 5 1000
revenue 0 0
0 0 0 0 0 0 00
Variable 30 333 3 4 4 4 5 5 5 600

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 6 9 2 5 8 1 47
costs 0 0
0 0 0 0 0 0 00
2 2 2 3 3 3 33
Gross profit20 22
4 6 8 0 2 4 6 8 400
margin 0 0
0 0 0 0 0 0 00
3 3 3 3 3 3 33
30 30
Fixed costs 0 0 0 0 0 0 0 0 300
0 0
0 0 0 0 0 0 00
- - - -
- 2 4 68
Net profit 10 6 4 2 0 100
80 0 0 00
0 0 0 0
Table T-9.1 shows that the break-even sales volume is at 150 units. At this
level of sales volume, the total revenue is $750 and total cost is $750 ($300
+ 150x$3). We can also calculate the break-even volume Q with the
formula above
Q = 300 / (5 - 3) = 300 / 2 = 150

The analysis is usually conducted on a graph such as Graph G-9.1 which

reproduces the data given in Table T-9.1 above.
Graph G-9.1

The graph shows the total sales revenues are rising with each additional
unit sold at the rate of price P (i.e. $5), the total cost starts at FC and is

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rising at the rate of unit variable cost UVC (i.e. $3). PROFIT is zero where
TOTAL COST intersects REVENUE (i.e. that is where units sold equal 150).
2)- Interpretation of break-even analysis
The actual (or projected) sales volume is compared with the break-even
volume. If the actual volume is smaller or very close to the break-even
volume, it indicates that either the pricing strategy should be revised or the
product should be discontinued because it is not sufficiently profitable. If the
actual volume is only slightly above the break-even volume, the profitability
may be adequate or not depending on the sales stability. If sales are
unstable the actual sales must be significantly above the break-even
volume; otherwise, there is a good chance that falling revenues will put the
company in financial difficulty.
This approach brings into focus an aspect of sales touched upon earlier. That
is the importance of a permanent clientele. Brand loyalty is of great
importance to a firm and needs to be maintained and enhanced. Losing
customers is unforgivable, even if it is the result of actions by competitors,
but especially if the cause is attributable to the firm itself.
3)- Extensions of break-even analysis
There are several variations of the break-even analysis. The break-even
analysis by product lines illustrates the pattern of sales with different
contribution margins. Lower profit margin products are mature products with
stable markets; they make up total sales revenue starting from zero and
rising in lower left portion of the curve. Higher profit margins products are
newer products with unstable markets; they add to total sales revenue to
the right. The higher margin products may be those with the greatest
potential threat from competitors. The graph then shows whether the sales
on the more risky products may put the company in financial difficulty.
Another interpretation of this presentation is that the lower contribution
margin sales can be viewed as necessary to absorb some of the fixed costs,
so that the higher contribution margin products can be produced.
Conclusion
All the above discussion shows that accounting is play a very vital role in the
firms or business check and balance as well as with the help accounting
managers make good decision making for the future.

References

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http://www.smccd.net
http://en.wikipedia.org
http://bing.com

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