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Assumptions
and
Limitations of
Break-even
Analysis
 By
Jomon Jacob
1021904
One of the assumptions to study break-even analysis is that the total revenue and total
cost is a linear curve.

Assume TC= 100+ 10Q

TR = 15Q

This implies that the total fixed cost

of the firm is given at Rs 100 and its
variable cost at a rate of Rs 10 per
unit of production. The revenue
function implies the product is given
at Rs 15 per unit.

When this is plotted as shown is graph above, the TR and TC curve intersects at a
point. At any output below this point, the firm is producing under a loss and at any
point above this point, it is running on profit. Thus this intersecting point is called as
the Beak-even point and the output corresponding to this is called as the break-even
output.

But the assumption of linearity is not valid in the real world. As shown above, the TR
and TC curve intersect only at a single point, which gives the impression that all
output above break-even is a profit. This is not true.
In real world, the cost and revenue functions are non linear. This non linearity arises
because AVC and price vary with variation in output. As a result TC may increase at
an increasing rate and TC revenue increases at
a decreasing rate.

Thus at some stage of output the TC may

exceed TR. We will then have two intersecting
points as shown in the figure. Now we have a limited range of profitability ie.
between B1 and B2.

In this graph the vertical distance between TFC and TC is the TVC. Also the vertical
distance between TR and TC is the profit or loss at various levels of output.

Thus for the whole range of output between points B1 and B2, the firm runs with a
profit. If the output is less than B1 or greater than B2, firm has to incur a loss.

Limitations of Break-even Analysis

One of the glaring limitation is break-even analysis is as discussed before, the

assumption of linearity. This assumption though can be removed by pre testing the
cost and revenue function and by using non- linearity conditions. There are other few
limitation as well in using break-even analysis.

a) The break-even analysis can be applied only to a single product system. Under
the condition of multiple products and joint operations, the break-even
analysis can be applied only if product wise cost is ascertained, which is very
difficult.
b) Break-even analysis cannot be applied usefully where cost and price data
cannot be ascertained beforehand and where historical data are not relevant for
estimating future cost and price.

Despite these limitations, break-even analysis may serve as a useful tool in

production planning, if relevant data can be easily obtained.