Break-even (economics)

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This article is about Break-even (economics). For other uses, see Break-even (disambiguation).

The Break-Even Point is where Total Costs equal Sales. In the Cost-Volume-Profit Analysis
model, Total Costs are linear in volume.

In economics & business, specifically cost accounting, the break-even point (BEP) is the point at
which cost or expenses and revenue are equal: there is no net loss or gain, and one has "broken
even". A profit or a loss has not been made, although opportunity costs have been paid, and capital
has received the risk-adjusted, expected return.[1]

For example, if a business sells less than 200 tables each month, it will make a loss, if it sells more,
it will be a profit. With this information, the business managers will then need to see if they expect
to be able to make and sell 200 tables per month.

If they think they cannot sell that much, to ensure viability they could:

1. Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control of
telephone bills or other costs)
2. Try to reduce variable costs (the price it pays for the tables by finding a new supplier)
3. Increase the selling price of their tables.

Any of these would reduce the break even point. In other words, the business would not need to
make so many tables to make sure it could pay its fixed costs.

[edit] Computation
In the linear Cost-Volume-Profit Analysis model,[2] the break-even point (in terms of Unit Sales
(X)) can be directly computed in terms of Total Revenue (TR) and Total Costs (TC) as:
where:

• TFC is Total Fixed Costs,

• P is Unit Sale Price, and
• V is Unit Variable Cost.

The Break-Even Point can alternatively be computed as the point where Contribution equals Fixed
Costs.

The quantity is of interest in its own right, and is called the Unit Contribution Margin
(C): it is the marginal profit per unit, or alternatively the portion of each sale that contributes to
Fixed Costs. Thus the break-even point can be more simply computed as the point where Total
Contribution = Total Fixed Cost:

In currency units (sales proceeds) to reach break-even, one can use the above calculation and
multiply by Price, or equivalently use the Contribution Margin Ratio (Unit Contribution Margin

over Price) to compute it as:

R=C Where R is revenue generated C is cost incurred i.e. Fixed costs + Variable Costs or Q X
P(Price per unit)=FCT + Q X VC(Price per unit) Q X P - Q X VC=FC Q (P-VC)=FC or Break
Even Analysis Q=FC/P-VC=Break Even ®®

[edit] Margin of Safety

Margin of safety represents the strength of the business. It enables a business to know what is the
exact amount he/ she has gained or lost and whether they are over or below the break even point.[3]

margin of safety = (current output - breakeven output)

margin of safety% = (current output - breakeven output)/current output x 100

If P/V ratio is given then profit/ PV ratio

== In unit Break Even = FC / (SP − VC)

where FC is Fixed Cost, SP is Selling Price and VC is Variable Cost

[edit] Break Even Analysis

By inserting different prices into the formula, you will obtain a number of break even points, one
for each possible price charged. If the firm changes the selling price for its product, from $2 to
$2.30, in the example above, then it would have to sell only (1000/(2.3 - 0.6))= 589 units to break
even, rather than 715.

To make the results clearer, they can be graphed. To do this, you draw the total cost curve (TC in
the diagram) which shows the total cost associated with each possible level of output, the fixed
cost curve (FC) which shows the costs that do not vary with output level, and finally the various
total revenue lines (R1, R2, and R3) which show the total amount of revenue received at each
output level, given the price you will be charging.

The break even points (A,B,C) are the points of intersection between the total cost curve (TC) and
a total revenue curve (R1, R2, or R3). The break even quantity at each selling price can be read off
the horizontal axis and the break even price at each selling price can be read off the vertical axis.
The total cost, total revenue, and fixed cost curves can each be constructed with simple formulae.
For example, the total revenue curve is simply the product of selling price times quantity for each
output quantity. The data used in these formulae come either from accounting records or from
various estimation techniques such as regression analysis.

[edit] Application

The break-even point is one of the simplest yet least used analytical tools in management. It helps
to provide a dynamic view of the relationships between sales, costs and profits. A better
understanding of break-even, for example, is expressing break-even sales as a percentage of actual
sales—can give managers a chance to understand when to expect to break even (by linking the
percent to when in the week/month this percent of sales might occur).

The break-even point is a special case of Target Income Sales, where Target Income is 0 (breaking
even).

[edit] Limitations
 • Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing
about what sales are actually likely to be for the product at these various prices.
• It assumes that fixed costs (FC) are constant. Although, this is true in the short run, an
increase in the scale of production is likely to cause fixed costs to rise.
• It assumes average variable costs are constant per unit of output, at least in the range of
likely quantities of sales. (i.e. linearity)
• It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e.,
there is no change in the quantity of goods held in inventory at the beginning of the period
and the quantity of goods held in inventory at the end of the period).
• In multi-product companies, it assumes that the relative proportions of each product sold
and produced are constant (i.e., the sales mix is constant).

roject Appraisal Report

Feasibility Report and Project Appraisal

1) General Information

a) Name

b) Constitution and sector

c) Location

d) Nature of industry and product

e) Promoters and their contribution

f) Cost of project and means of finance

2) Promoters Details

3) Market Feasibility Report

a) Segments

b) Competition

c) Pricing

d) SWOT Analysis

e) Marketing and Selling Arrangements

4) Particulars of the Project

a) Product and Capacity

b) Plant and Machinery

c) Raw Material

d) Utilities
5) Technical Feasibility Report

a) Technology

b) Alternatives

c) New Developments

d) Competing Technologies

e) SWOT Analysis of technology

f) Technical Arrangement

6) Production Process

7) Environmental Aspects

8) Schedule of Implementation

9) Financial Feasibility

a) Cost Details

b) Working Capital

c) Means of Finance

d) Profitability Estimates

e) Assumptions

f) Projections

i) Projected Income Statement

ii) Projected Balance Sheet

iii) Projected Cash Flow Statement

iv) Coverage Ratio’s

v) Break Even Analysis

10) Economic Consideration

11) Appendices

a) Depreciation Schedule

b) Repayment, interest schedule of term loan and bank finance

c) Working Capital and margin money for working capital schedule

d) Tax Computation

e) Details of Plant and Machinery

f) Requirement of skilled and unskilled labor

g) Cost of Project Details

Aspects of Project Appraisal

1. Market Appraisal.
2. Technical Appraisal.
3. Financial Appraisal.
4. Economic Appraisal.

1. Market Appraisal.

The market appraisal is attempted to answer two important questions.

(i) What is the size of the total market for the proposed product or service?

(ii) What is the product's share of total market?

Market Appraisal.

Two answer the questions market analyst complies and analysis the date relating to the following
aspect.

(a) Past & present trends.

(b) Present and prospective supply position.

(c) Level of imports and exports.

(d) Structure of competition.

(e) Price and cross elasticity of demand

(f) Consumer requirements.

(g) Production constraints.

1. Technical Appraisal.

(i) Availability of the required quality and quantity of raw material.

(ii) Availability of utilities like power and water etc.

(iii) Appropriateness of the plant designs and layout.

(iv) The proposed technology vis a vis alternative technologies available.

(v) Optimality of scale of operations.

(vi) The technical specifications of plant and machinery in relation to the proposed technology.

(vii) Assembly line balancing.

1. Financial Appraisal.

(i) Cost of project

(ii) Means of financing.

(iii) Projected Revenue and cost.

(iv) Pay back period.

(v) NPV

(vi) Rate of return.

(vii) Internal Rate of Return.

1. Economic Appraisal.

(i) Impact of the project one the distribution of income in the society.

(ii) Impact of project on the level savings and investment in the society and socially desirable
objectives like self sufficiently, employment etc.

(iii) Contribution of project.

Assessing project feasibility – Market.

(i) Selecting target market.

(ii) Measuring selected market.

Measurement of target market

(i) Demand

(ii) Supply

(iii) Distribution.

(iv) Prices.

(v) Government Policies.

Assessing Project Feasibility – Technical

(i) Selection of technology.

(ii) Manufacturing process.

(iii) Estimation of Inventory requirement.

(a) Raw Material Survey.

(iv) Selection of equipment.

(v) Plant Layout.

(vi) Plant Capacity

(a) Installed capacity.

(b) Capacity Utilization.

(vii) Utilities – Availability.

(a) Water

(b) Electricity

(c) Other Utilities.

(viii) Estimation of manpower needs.

(ix) Estimation of Building needs.

(x) Selection of project location.

(a) Nature of land.

(b) Nature of raw material.

(c) Utilities

(d) Effluent disposal.

(e) Transport.

(f) Labour.

Implementation Schedule.

4. Assessing Project Feasibility. Financial Projections

(i) Cost of Project.

Land and site develiopment.

(a) Availability of investment subsidy.

(b) Availability of concessional finance.

(c) Sales tax determents/exemptions.

(d) Income tax benefit.

Building and civil works.

Plant and machinery.

(a) Basic cost of indigenous machines.

(b) Basic cost of imported machines.

(c) Duties on indigenous machinery.

(d) Duties on imported machinery.

(e) Other expenses – erection charges etc.

(iv) Miscellaneous fixed assets.

(v) Preliminary expenses (2.5% of cost of project)

(vi) Preoperative expenses.

(a) Promotional expenses.

(b) Organizational and training cost.

(c) Rent, Rates, taxes.

(d) Travelling expenses.

(e) Postage, telegrams and telephone expenses.

(f) Printing and stationery expenses.

(g) Advertisement expenses.

(h) Guarantee commission.

(i) Insurance during construction.

(j) Interest during cons. period.

(vii) Provision for contingencies.

(a) Firm Cost – 5%

(b) Non Firm cost – 10%

(viii) Technical know how fees.

(ix) Margin money for working capital.

(x) Means of finance.

(a) Equity capital

(b) Performance capital.

(c) Debenture capital.

(d) Term loan.

(e) Deferred credit.

(f) Unsecured loans and deposits.

(g) Capital subsidy and development loans.

(xi) Fixing Means of finance.

(a) Debt-equity ratio

(b) Promoters contribution.

(xii) Sales Estimation

(a) Cost of production

(b) Product mix

(c) Installed capacity

(d) Capacity utilization.

(xiii) Elements of cost of production.

(a) Raw materials

(b) Chemicals.

(c) Components.

(d) Consumables.

(e) Total raw material cost (a)+(b)+(c)+(d)

(f) Utilities

(g) Power

(h) Water

(i) Fuel

(ii) Total utilities (e)+(f)+(g)+(h)

(j) Wages
(k) Factory supervision and salaries.

(m) Bonus and PF

(iii) Total Labour (i)+(j)+(k)

(o) Repairs & maintenance

(p) Light

(q) Rent & taxes on factory.

(r) Insurance on factory assets.

(s) Packing material.

(t) Miscellaneous factory overheads.

(u) Contingency at 5%.

(iv) Total factory overheads ( o to u)

(v) Cost of manufacturing/operating cost (i) + (ii) + (iii) + (iv)

(vi) Total Administrative expenses.

(vii) Total sales expenses.

(viii) Royalty and know how payable.

(ix) Total cost of production (v) + (vi) + (vii) + (viii).

4. Assessing Project Feasibility - Financial Appraisal.

(i) Cost & benefits are measured in terms of cash flow i.e. cash in flow and cash outflow.

(ii) Evaluating projects in terms of costs and benefits is based on marginal or incremental cash
flows. The marginal or incremental cash flows. The marginal cash flow is the change in total firm
cash flow from adopting that investment.

(iii) As already mentioned n (i) above cash flows are always measured in post tax terms as that
represents net flow from the firm point of view.

(iv) Focus should be on long term funds.

Evaluation Techniques.

(i) Present value.

(ii) Internal rate of return (simply rate of return).

(iii) Payback period.

(iv) Accounting rate of return.

(v) Debt service coverage ratio.

(vi) Benefit cost ratio.

Present Value.

The present value of a cash flow is, flow what it worth in today.

It states that an investment should be adopted only if the present value of the cash it generates in
future exceeds its cost.

NPV = Present value of cash flow – Initial cost.

= CF1 (PVIF,K,I)+-------------------

Internal Rate of Return –

An internal rate of return is the rate we expect to earn on an investment of project. IRR is that rate
which discounts a projects cash flow to an NPV=0.

CF CF CF

0 = ----- + ----- + ------- ------ - I

1+r (1+r)2 (1+r)n

= CF(PV1FA,r,n) – I

PAY BACK PERIOD :

The pay back period measures the length of time required to recover the initial investment on a
project.

ACCOUNTING RATE OF RETURN –

The accounting rate of return (ARR) equal the average annual after tax accounting profit generated
by the investment divided by the average investment.

average annual profit

ARR = ------------------------------
(1 – s)

DEBT service coverage ratio –

The capacity of the project to meet the interest payment and principal repayments on time.
1 n PA Tt + Dt + It

DSCR = --- S ------------------------

n t=1 It + Lt

PA Tt = Profit after tax in year t.

Dt = Depreciation charge in year t.

It = Interest on long term loans in year t.

n = Period over which the loan has to be repaid.

Benefit cost ratio (BCR)

PV

BCR = ------

BCR = Benefit Cost Ratio

PV = Present value of future cash flows.

I = Initial investment

BCR > 1 NBCR > 0 Accept

BCR < 1 NBCR < 0 Reject

Break Even Point.

The point at which the entire fixed costs are covered.

Fixed Cost

BEP = -----------------------------------

Sales price - variable cost

Fixed cost

= -----------------------

Contri bution

POINTS TO BE DISCUSSED

1. Debt Equity Ratio – Chaebol Korea/BPL

2. Rate of interest/Subsidy/optional sources-Enron/BPL

3. Working capital management/Bajaj/SME main problem.

Repayment cycles 30/60/90

4. Turn around – Restructuring

i. Steel industry in India

ii. Daewoo

iii. SME