Cost
&
Break - even Analysis
Viqar Ahmed
Chapter Objectives
Classification of Business Costs
The usefulness of cost data in business decision
making.
Break-Even Analysis
Economies & Diseconomies of Scale
Cost
Cost: The amount of money incurred to produce.
Businesses wants to make many decision based on
the accurate data about the costs involved
Businesses have to pay for the resources they use,
which includes
-Wages -Raw material -Rent -Machinery
All these are known as costs
Some costs stay same when business produces more
or less output
But some costs changes according to the level of
output
Classification of Costs
Fixed Variable Total Average
Costs Costs Costs Costs
Fixed Cost
Costs that do not change with the level of output.
A fixed cost will be same when the output is Zero
and when the production is at maximum output
Ex: Rent, Salary of managers
Variable Costs
Costs that changes in direct proportion to the
output.
Variable cost will be Zero when the output is Zero,
it will be 50% when the production is 50%.
Ex: Raw material, Wages (Piece Rate)
If Variable costs per unit is $ 50
Business produces 500 units then
Total Variable Cost will be 50 x 500 = $25000
Total Variable Cost = Variable cost per unit x No of units
Total Costs
All the variable costs and fixed costs of producing the total
output
Total Costs = Fixed Costs + Total Variable Costs
100
90
80
70
60
50 Fixed cost
Variable Costs
40
Total Costs
30
20
10
Fixed cost Variable Costs Total Costs
Average Costs
The cost of producing a single level of output
Total Cost
Average Cost =
No of units produced
If the business produces 1200 units and the total cost is 25000
Then Avg cost will be 25000/1200 = 20.83
That means it cost $ 20.83 for the business to
produce 1 (one) unit
How to Plot Costs on
Graph
Y axis
$ 000
60
Total Cost
50
40 Variable Cost
30
20
Fixed Cost
10
X axis
0 10 20 30 40
No of Units (000)
The Usage of Cost Data
Businesses uses cost data for making decisions
like
Setting Price
Break – Even Analysis
To Continue or Stop producing the product
Break - even
Analysis
Break Even
A situation where a business is neither making profit
nor loss.
The revenue a business earns from selling its output
exactly equals the total cost of producing output.
If revenue generated is More
than the cost then business
earns PROFIT.
If revenue generated is Less
than the cost then business will
make a LOSS.
The Purpose of Break Even Analysis
Businesses uses this technique to show the relationship
between Revenue, Costs at different level of output.
It is used to calculate
How many units business needs to sell before it starts to make a
profit
The effect on profit by increasing or decreasing the product’s price
The effect on profit by increasing or decreasing the business costs
To Product Break Even Charts, following info is needed
Revenue at Zero output and maximum output
Total Cost at Zero output and maximum output
Fixed Cost at Zero output and maximum output
To Calculate Break Even point, following info is needed
Fixed Cost
Variable Cost per unit
Selling price per unit
Fixed Cost
Break Even Point = Selling Price - Variable Cost per Unit
Margin of Safety is the amount by which actual sales exceed the break even pt
Margin of Safety = Actual sales – Break even output
Limitation of Breakeven Chart
The Total Cost & Total Revenue are shown in
straight lines, in practical they may not be
straight (If business offers discounts then TR
will fall)
Its an Prediction: (Business assumes to sell
total output and holds no stock, which in
practical not possible always)
Accuracy of Data: The quality accuracy of
BE Chart depends upon the accuracy of data
(if data in unauthentic then decision may be
wrong)
Scale of
Production
Scale = The size of the business
operations
As the business grows the output grows and business
benefits from of Economies of scale
Sometimes, business grows so large that it experiences
opposite i.e. Diseconomies of Scale
Avg
Cost
Diff Types of No of Units Diff Types of
Economies of Scale Diseconomies of Scale
1. Financial Economies 1. Poor Communication
2. Managerial Economies 2. Lack of Commitment
3. Marketing Economies from Employees
4. Purchasing Economies 3. Week Coordination
5. Technical Economies 4. Bureaucracy
Jazakallah Khair
Questions/Queries
