IMPORTANCE OF BREAK-EVEN
POINT FOR A MANAGER IN
DECISION MAKING
MBA - 1st SEMESTER
Group No - 7
Group Members RollNo
ANKITA DAS - 50
DEEPA BAIDYA - 16
MOUMITA CHANDA - 43
SILADITYA MUKHERJEE - 17
BREAK-EVEN POINT
Definition:- 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.
A company's break-even point is the amount of sales or revenues
that it must generate in order to equal its expenses. In other words, it is the
point at which the company neither makes a profit nor suffers a loss.
Calculating the break-even point (through break-even analysis) can provide
a simple, yet powerful quantitative tool for managers. In its simplest form,
break-even analysis provides insight into whether or not revenue from a
product or service has the ability to cover the relevant costs of production
of that product or service. Managers can use this information in making a
wide range of business decisions, including setting prices, preparing
competitive bids, and applying for loans.
BACKGROUND:-
The break-even point has its origins in the economic concept of the "point
of indifference." From an economic perspective, this point indicates the
quantity of some good at which the decision maker would be indifferent,
i.e., would be satisfied, without reason to celebrate or to opine. At this
quantity, the costs and benefits are precisely balanced.
Similarly, the managerial concept of break-even analysis seeks to find the
quantity of output that just covers all costs so that no loss is generated.
Managers can determine the minimum quantity of sales at which the
company would avoid a loss in the production of a given good. If a product
cannot cover its own costs, it inherently reduces the profitability of the firm.
CALCULATION:- BEP(in terms of quantity)
In the linear Cost-Volume-Profit Analysis model 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:-
At BEP, TR=TC
S*Qь=TFC+TVC
S*Qь=TFC+ (V*Qь)
(S-V)Qь=TFC
Qь=TFC/(S-V)
Where ,
Qь=Break-even quantity
TR-total revenue , TC-total cost
TFC=total fixed cost, TVC-total variable cost
S-selling price/ unit , V-variable cost/unit
CALCULATION :- BEP (in terms of sales)
From the above formula,
We know that, Qь=TFC/(S-V)
Now, Sь = TFC/PV ratio
Sь = TFC/{(S-V)/S}
Sь = TFC/(1-V/S)
Sь =TFC/CMR
Where,
Sь - Break-even sales .
(S-V) - contribution/unit, (S-V)/S - PV ratio,
(1-V/S) - contribution margin ratio.
CMR - Contribution Margin Ratio.
The quantity is called the Unit Contribution Margin .
Total revenue-This is the total amount of money a firm receives from
selling goods or services
It is calculated using the following formula:TR=S*Qь.
For example:-, if a firm sells 1 sweet for 10p, it’s
total revenue will be (1 x 10p) 10p
If the same firm sold 10 sweets for 10p each it
would receive in total (10 x 10p) £1.00
Total Revenue (TR) = Price per unit x Number of units sold
Total Cost:-This is the total amount of money a firm spends on
making goods or services
It is calculated using the following formula: TC= TFC+TVC
Where:
Total Fixed Costs = All fixed costs added together
Total Variable Costs = Variable cost per unit multiplied by the number of
units
Fixed Cost :- Costs that remain mostly constant despite what the Sales
Volume may be. Fixed Costs remain constant in a certain range, after
which they change, particularly, after a steep increase in Sales (i.e. you
need a bigger building or more employees). It is important to understand
that these costs must be paid no matter whether the company makes sales
or not.
Fixed Cost include:
- Overhead Costs: Rent, Office / Administrative Costs, Salaries, Benefits,
FICA and so forth.
- Interest Charges: For Term Loans and Mortgages.
- Hidden Costs: Depreciation, Amortization and Interest.
Variable Cost :- Costs directly associated with the Sales level and
include:
- Costs of Goods Sold
- Variable Labor Costs
- Sales Commissions
Break-even Analysis
Break-even analysis is a technique to establish the effect on profit
of different sales volumes and
different costs and selling price levels. The break-even point is the
volume of sales at which sales
enable costs to be covered and no profit or loss is made - in other
words, you break even.
Break-even analysis can be a very useful management tool
because it enables a manager to determine the following things:
• The profitability of the present product line.
• How far sales can decline before losses will be incurred?
• How many units have to be sold before it becomes profitable?
• What effects will the reduction in selling price or the volume of
sales made have on the profitability of the business?
• What will be the effect on profitability if overhead expenses
increase?
• How much more has to be sold at current price levels to make
up for an increase in the cost Of sales.
Advantages-
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).
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).
