Break-Even Analysis BEA

What is BEA ?
Before incurring exp., mangers want to know whether they would get a return on Investment? [for eg., to assess the financial feasibilty of marketing investments] BEA ( or finding the BE point) is one way to find that!!!

BEP calculates the no. of (additional units) the firm needs to sell to cover the cost of the programme.

The BE Formula
A brief Recap: 1. Cost Function = FC + VC 2. VC = c * q , (c = variable cost per unit) 3. Revenue = p * q , ( p =price per unit) & here we State that 4. at BE , TR = TC

 So, BE quantity (BEQ) is the unit qty. which yields zero profits to the firm. i.e., at BE, TR = TC. TR [ ie.,(p*q)] = TC [ ie.,(c*q + FC)] [Here, q is common to both sides of this equation]

From TR = TC, Weve p * q = c * q + FC ie., p*q c*q = FC Or, (p-c)q = FC Or q = FC / (p-c) ie., the BEQ = FC / [( price/unit)-( cost/unit)]

BEQ = FC / contribution margin per unit

To sum up..
to calculate a BEP to understand how many units of a product we need to sell to cover our costs, we need to know the fixed costs of the programme and the amount of profit we make from each unit we sell

Graphical representation..

What after calculating theBEQ?

Determine how the numbers influence the decision that has to be made. Assess the feasibility of selling the BEQ as a result of the planned investment

Risk assessment to calcualte the probabilty of success for selling the BEQ..

 Determine the period the firm will take to achieve break evenby relating BEQ to time.. This is sometimes called the Payback Period- the period of time the firm needs to pay back its investment..

The longer the payback period the higher is the risk element for the firm..WHY???

Example 1
Firm Q-matrix sells a product at Rs. 35 per unit. The VC for the product is Rs.30 per unit and its FC is Rs. 70000. What is the qty.of product, the firm must sell in order to BreakEven?

 Solution: Cost = FC + VC = 70000 + 30q Revenue = p *q = 35q At BEP, R = C, .OR 35 q = 70000 + 30 q

35q -30 q = 70000 5 q = 70000 or q = 70000 / 5 = 14000 Hence the firm must sell 14000 units to break even

 Alternatively, BEQ = FC / per unit margin contribution = 70000 / (35-30) = 70000 / 5 = 14000 units

Example 2
Okhla Printing Co. gets a contract to print economics text books. It is estimated that it would incur a VC cost of Rs.33/- per book and a FC of Rs. 4,50,000. The no. of books that need to be sold to Break-even is 37500 units. Find the selling Price per unit of book?

 Solution : Cost = FC + VC =450000 + 33q = 450000 + 33(37500) Revenue = p* q = p* 37500 At BE, R= C,.PTO

 P*37500 = 450000 +33(37500} P * 37500=450000 + 33( 37500) 37500 P= 450000 +1237500 37500 P = 1687500

SO P= 1687500/37500 = 45. Therefore, the selling price at BE is Rs. 45/-

Eg.3.
Big Cinemas in Meerut sells a ticket for the 9.00 am show @Rs. 45/-. The cost function for this product is C(q)= 33q + 4800. 1.Find the no. of tickets Big Cinemas need to sell for this show to BE 2. If it is known that the seating capacity of the cinema hall is 100 and the show for which ticket price is Rs. 45 is run only for one day in a week, estimate the Payback period for the show, assuming that the cost function remains the same

Solution:
R C= = p * q = 45q 33q +4800

At BE , R=C, & 45q = 33q +4800 , or 12 q =4800 q = 400. Big cinemas should sell 400 tickets to Break even Whats the PAYBACK Period?