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G.L.

BAJAJ INSTITUTE OF MANAGEMENT & RESEARCH

GREATER NOIDA

SUBJECT: COST & CONTROL MANAGEMENT

PRESENTATION REPORT

TOPIC : BREAK EVEN ANALYSIS RELEVANT FOR DECISION MAKING

TEAM 1

PRIYA SINGH
ARAVIND KRISHNA
NAINA MITTAL
SHIVANK
RISHA
SHRISHTI KESHARI
SAAGAR SINGHAL
Contents
INTRODUCTION ..................................................................................................................... 3
Break Even Analysis .................................................................................................................. 3
Components of Break Even Analysis ........................................................................................ 4
How to Calculate BEP? ............................................................................................................. 6
Assumptions of Break Even Analysis........................................................................................ 6
Uses of Break-Even point analysis ............................................................................................ 7
Limitations of Break Even Point Analysis................................................................................. 7
Contribution Margin Analysis ................................................................................................... 7
Contribution Analysis in Break Even Chart: ............................................................................. 8
Example of Contribution Analysis............................................................................................. 9
How do Companies use it? ................................................................................................... 10
Target Profit ............................................................................................................................. 10
Formula for Target Profit: ................................................................................................ 10
Margin Of Safety ..................................................................................................................... 11
Example of Margin of Safety ............................................................................................... 11
Formula of MOS:.............................................................................................................. 11
MOS in Break Even Chart ................................................................................................... 12
Ways to improve Margin of safety:...................................................................................... 12
Difference between Breakeven Point vs. Margin of Safety ..................................................... 12
CONCLUSION ........................................................................................................................ 14
INTRODUCTION
Break Even Analysis:

Break-even analysis is a technique widely used by production management and management


accountants. It is based on categorising production costs between those which are "variable"
(costs that change when the production output changes) and those that are "fixed" (costs not
directly related to the volume of production).

Total variable and fixed costs are compared with sales revenue in order to determine the level
of sales volume, sales value or production at which the business makes neither a profit
nor a loss (the "break-even point").

This analysis is a financial tool which helps you to determine at what stage your company, or
a new service or a product, will be profitable.

In other words, it’s a financial calculation for determining the number of products or services
a company should sell to cover its costs (particularly fixed costs).

Break-even is a situation where you are neither making money nor losing money, but all your
costs have been covered.

Break-even analysis is useful in studying the relation between the variable cost, fixed cost
and revenue.

Generally, a company with low fixed costs will have a low break-even point of sale.
Components of Break Even Analysis

1. Fixed Costs

Fixed costs are those business costs that are not directly related to the level of
production or output. In other words, even if the business has a zero output or high
output, the level of fixed costs will remain broadly the same. In the long term fixed
costs can alter - perhaps as a result of investment in production capacity (e.g. adding a
new factory unit) or through the growth in overheads required to support a larger,
more complex business.

Examples of fixed costs:


- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs

2. Variable Costs

Variable costs are those costs which vary directly with the level of output. They
represent payment output-related inputs such as raw materials, direct labour, fuel and
revenue-related costs such as commission.

A distinction is often made between "Direct" variable costs and "Indirect" variable
costs.

Direct variable costs are those which can be directly attributable to the production of
a particular product or service and allocated to a particular cost centre. Raw materials
and the wages those working on the production line are good examples.

Indirect variable costs cannot be directly attributable to production but they do vary
with output. These include depreciation (where it is calculated related to output - e.g.
machine hours), maintenance and certain labour costs.
3. Revenue : is the income generated from normal business operations and includes
discounts and deductions for returned merchandise. It is the top line or gross income
figure from which costs are subtracted to determine net income.

4. Profit: Profit describes the financial benefit realized when revenue generated from a
business activity exceeds the expenses, costs, and taxes involved in sustaining the
activity in question. Any profits earned funnel back to business owners, who choose to
either pocket the cash or reinvest it back into the business. Profit is calculated as total
revenue less total expenses.
How to Calculate BEP?

Assumptions of Break Even Analysis


1. The total costs may be classified into fixed and variable costs. It ignores semi-variable
cost.
2. The cost and revenue functions remain linear.
3. The price of the product is assumed to be constant.
4. The volume of sales and volume of production are equal.
5. The fixed costs remain constant over the volume under consideration.
6. It assumes constant rate of increase in variable cost.
7. It assumes constant technology and no improvement in labor efficiency.
Uses of Break-Even point analysis

1. Measure profit and loss at different level of production and sales

2. Predict the effect of changes in sales price.

3. Analyse the relationship between fixed and variable costs.

4. Predict the effect of cost and efficiency changes on profitability.

Limitations of Break Even Point Analysis

1. Assume that sales prices are constant at all level of output.

2. Assume production and sales are the same.

3. Break even chart may be the time consuming to prepare.

4. It only applies to a single product or single mix of product.

Contribution Margin Analysis


What is Contribution?

"Contribution" represents the portion of sales revenue that is not consumed by variable
costs and so contributes to the coverage of fixed costs. This concept is one of the key
building blocks of break-even analysis.

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

C=P−V
Contribution Analysis in Break Even Chart:

Contribution Margin Shown in Cost Chart in Yellow Colour.

Contribution Margin Shown in Break Even Chart in Blue Colour.


Example of Contribution Analysis
Beta Sales Company Contribution Format Income Statement for Year Ended December 31,
201X

Sales $ 462,452

Less Variable Costs

Cost of Goods Sold $ 230,934

Sales Commissions $ 58,852

Delivery Charges $ 13,984

Total Variable Costs ($ 303,770)

Contribution Margin (34%) $ 158,682

Less Fixed Costs

Advertising $ 1,850

Depreciation $ 13,250

Insurance $ 5,400

Payroll Taxes $ 8,200

Rent $ 9,600

Utilities $ 17,801

Wages $ 40,000

Total Fixed Costs ($ 96,101)

Net Operating Income $ 62,581


How do Companies use it?
1. To compare products and determine which to keep and which to get rid of.

2. Helps in understanding cost structure of businesses.

3. Helps in managing Product portfolios of companies and it’s costs.

4. Helps in differentiating between fixed costs and variable costs.

Target Profit

Target profit analysis is about finding out the estimated business activities to perform to
earn a target profit during a certain period of time. Among these activities, management is
especially interested to find out the sales volume required to generate a target profit.

In break-even point analysis article, we used equation method and contribution margin
method to calculate break-even point of a company. The same formulas, with a little
modification, can be used to calculate the sales both in units and in dollars to earn a target
profit during a certain period of time.

Formula for Target Profit:

Example
• The HK company manufactures a single product – product X. A unit of product X is
sold to customers for $80(selling price). The per unit variable expense and the total
expected fixed expenses for the year 2012 are as follows:

• Variable cost per unit: $50

• Total fixed expenses: $40,000

• The company wants to earn a profit of $80,000 for the year 2012.
Answer :

• Contribution margin method:

• (Target profit + fixed expenses)/contribution margin per unit

• = ($40,000 + $80,000) / $30*


= 4,000 units

• 4000 units is required to be produced by the company to reach a profit of $80000

Margin Of Safety
In break-even analysis, the term margin of safety indicates the amount of sales that are above
the break-even point. In other words, the margin of safety indicates the amount by which a
company's sales could decrease before the company will have no profit.

Example of Margin of Safety

Let's assume that a company currently sells 3,000 units of its only product. The company has
estimated that its break-even point is 2,800 units. Therefore, the company's margin of safety
is 200 units.

Formula of MOS:
MOS in Break Even Chart

Ways to improve Margin of safety:


1. Increase contribution per unit: By increasing selling price or lowering the variable
cost

2. Lowering Break-even Output: By reducing the Fixed overheads

3. Increasing sales volume: The easiest technique to increase the margin of safety is to
sell as much as the company can if there is underutilized capacity.

Difference between Breakeven Point vs. Margin of Safety

Break-even point (BEP) is the level of sales where a total of fixed and variable cost equals
total revenues. In other words, the breakeven point is a level where the company neither
makes profit nor loss.

A margin of safety (MoS) is a difference between actual/budgeted sales and level of


breakeven sales.
Although the breakeven point (level) and margin of safety fall under the broad domain of
cost-volume-profit analysis (CVP Analysis), they differ in various aspects. Main points of
difference between the breakeven point and margin of safety are as listed below:

Breakeven point means an amount of sales that covers entire fixed and variable cost. Sales
lower than the BEP will result in losses, while, the sales above the BEP will generate profit
after considering all the costs.

As the name suggests, Margin of Safety is the margin between the actual/budgeted sales and
breakeven point. It denotes the level of safety that company enjoys before incurring losses
(i.e. falling below the breakeven level).
CONCLUSION

1. Break-even analysis has a huge effect in planning, controlling and in the decision
making.

2. Break-even analysis is a very important and useful tool of financial management and
control.

3. Break-even analysis determines the relationship between costs and production volume
to forecast profit accurately at various levels of operations.