MANAGEMENT

ACCOUNTING
Breakeven Analysis

INTRODUCTION
It is very important for a company to work out
whether or not they are making a profit.
We can work out by writing up a Trading , profit
and loss account.
It is often useful to be able to predict profit or
loss in the future.
We can ascertain this using break even analysis.

Break-even Analysis Defined

It is a widely used technique to study cost volume price relationship.

It is interpreted as narrow as well as broad sense.

Narrow : the level of production and sales where there is no profit and no loss at
the point where total cost = total sales revenue.

Broad: it is used to determine probable profit & loss at any given level of
production/sales.
It also helps to determine the amount or volume of sales to earn a desired amount or
profit.

Assumptions underlying Breakeven Analysis

11-4

All costs are separated into fixed costs & Variable

components.
Variable costs per unit remains constant & total
variable cost varies in direct proportion to the
volume of production.
Fixed cost remain constant
S.P per unit does not change as volume changes.
There is only one product or incase of multiple
products the mix does not change.
Productivity per worker does not change.

Uses of Breakeven Analysis

Determining the break even point

Determining the selling price which will give the desire
profit.
Determining the sales volume to earn a desire profit or
return on capital employed.
It helps in determining the most profitable sales mix.
It helps in management decision making
It helps in determining cash requirement at different levels
of operation.

Methods of Breakeven Analysis

It may be performed by two method.

algebraic method:

graphical representation(break-even chart).

Breakeven Analysis Key

Terminology

Break even point- it is the point at which a company

makes neither a profit nor a loss.

Contribution per unit- the sales price minus the variable

cost per unit. It measures the contribution made by each item
of output to the fixed costs and profit of the organisation.

Margin of safety- It is defined as the difference between

actual sales and sales at break even point. size of margin of
safety indicates soundness of a business.

Marginal Cost it is composed of all direct costs &

variable overheads.

Breakeven Formula

Contribution per unit = Selling Price per unit

Variable Cost per unit.
Break even point(in units)=(Total fixed
cost)/contribution per unit
F/S-V

Example of Algebraic method

Using the following data, calculate the
breakeven point and margin of safety in
units:
Selling Price = Rs50
Variable Cost = Rs40
Fixed Cost = Rs 70,000
Budgeted Sales = 7,500 units

Solution

Contribution = 50 - 40 = 10 per unit

Breakeven point = 70,000/10 = 7,000 units
Margin of safety = 7500 7000 = 500 units

Graphical Representation-Breakeven
Chart

Limitations of B/E analysis

Assumption that all costs can be clearly separated into

fixed and variable components is not possible in actual
practice.

Assumption that variable cost per unit remains constant

and it gives a straight line is not always true.

Fixed costs also remains constant is also unrealistic. it is

constant only with limited range of output.

Assumption regarding Selling price remains constant as

volume changes is also not true.

Breakeven analysis completely ignores the

consideration of capital employed which may be an
important factor.

Conclusion

Break-even analysis is a powerful tool you can use to

determine whether your business idea will be profitable.

Even if this analysis shows that you can make a profit

given your expected sales and costs.