DR.

AVIJIT ROYCHOUDHURY
INSPECTOR OF COLLEGES
VIDYASAGAR UNIVERSITY
DEFINITION

Break-even analysis is the relationship between costs,

volumes and profits at various levels of sales & production,
with an emphasis placed on the break-even point. This point
is where the business achieves neither a profit nor a loss,
when total money received from sales is equal to total money
spent to produce them.
ASSUMPTIONS

1) The total costs are classified into fixed and variable

costs. It ignores semi-variable cost.
2)The price of the product is assumed to be constant
3)Variable cost per unit, selling price per unit and fixed
cost remains constant at all volumes of output.
4)There is either only one product or in case of multi-
products, the product mix remains unaffected.
5)Selling price per unit remains constant at all levels of
output.
6)The cost and revenue functions remain linear.
7) It assumes no improvement or deterioration in
technology and labour efficiency.
BREAK EVEN POINT

The break-even point may be defined as that point of sales

volume at which total revenue is equal to total cost. It is a
point of no profit, no loss. The break-even point refers to that
level of output where the costs and revenues evenly breaks
and hence the name. This is the point at which a business,
product, or project becomes financially viable.

At this point, contribution, i.e., sales reduced by marginal

cost, equals the fixed costs and hence this point is also called
as the ‘Critical Point’ or ‘Equilibrium Point’ or ‘Balancing
Point’. If production/sales are augmented beyond this level,
profit will accrue to the organisation and if it declines from
this level, there shall be loss to the organisation.
EQUATION OF BREAK-EVEN POINT
Sales revenue = Fixed Costs + Variable Costs.
COMPUTATION OF THE BREAK-EVEN POINT
The break-even point can be computed by the following
methods:
(i) The Algebraic Formula Method
(ii) Graphic or Chart Method.
ALGEBRAIC FORMULA METHOD
The break-even point can be computed in terms of:
(a) Units of sales volume.
(b) Budget total or in terms of money value.
(c) As a percentage of estimated capacity.
(a) Break-Even Point in Units:
Fixed Cost
𝐵. 𝐸. 𝑃. =
Selling Price per unit − Variable cost per unit
Fixed Cost
=
Contribution per unit
(b) Break-even Point in terms of budget-total or money value:
Fixed Cost
𝐵. 𝐸. 𝑆𝑎𝑙𝑒𝑠 = × Sales
Sales − Variable cost
Fixed Cost Fixed Cost
= × Sales =
Contribution P
Ratio
V
(c) Break-even Point as a percentage of estimated capacity:
Break Even Sales
𝐵. 𝐸. 𝑃. = × 100
Capacity sales
TYPES OF BREAK-EVEN POINT:
(i) Cash Break-Even Point:
The cash break¬even point may be defined as that point of
sales volume at which total revenue is equal to total cash cost.
At this point, cash contribution (which is calculated after
making adjustment for variable portion of depreciation, etc.)
equals the cash fixed cost, i.e., fixed cost excluding
depreciation and deferred expenses. This point enables the
management to determine the level of activity below which
the liquidity position of the firm would be adversely affected.
Thus, cash break-even point may be calculated as below:
Cash Break- Even Point (in Units) = Cash Fixed Cost/Cash
Contribution per unit
Illustration
From the following information, let us calculate the cash Break-Even
Point:
₹
Sales Price per unit 50
Variable Cost per unit 35
Depreciation included in the above per unit 10
Fixed Cost 1,25,000
Depreciation included in fixed cost 25,000
Solution:
Cash fixed Cost= ₹ (1,25,000 – 25,000 )= ₹ 1,00,000
Cash contribution per unit= ₹ 50-(35-10) = ₹ 25
𝐶𝑎𝑠ℎ 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 1,00,000
Cash Break Even Point= = =
𝐶𝑎𝑠ℎ 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 25
4,000 𝑢𝑛𝑖𝑡𝑠
Cash Break Even point in sales value = 4,000 x ₹ 50 = ₹ 2,00,000
(ii) Composite Break-Even Point:
So far we have dealt with break-even point of firms producing
single product. We can also calculate the composite break-
even point for a firm producing several products, as below:
Composite Break-Even Point (in Sales value) =
Total Fixed Cost
Composite P/V Ratio
Total Contribution
and, Composite P/V Ratio = × 100
Total Sales
Illustration :
From the following information of a company producing three products,
let us compute:
(a) Composite P/V Ratio, and (b) Composite Break-Even Point.

Product Sales Revenue(₹) Variable Cost(₹)

X 20,000 10,000
Y 40,000 14,000
Z 60,000 36,000
Fixed costs: Rs. 50,000.
Solution:
Product Sales Revenue Variable Cost Contribution P/V Ratio
𝐶
(₹) (₹) (S-V) (₹) 5
× 100

X 20,000 10,000 10,000 50%

Y 40,000 14,000 26,000 65%
Z 60,000 36,000 24,000 40%
Total 1,20,000 60,000 60,000 50%
 Total Contribution
Composite P/V Ratio = × 100
Total Sales
60,000
= × 100 = 50%
1,20,000

Composite Break-Even Point (in Sales value)

Total Fixed Cost
=
Composite P/V Ratio

50,000
= = 1,00,000
50%
Graphic Method of Break-Even Analysis:
The break-even chart portrays a pictorial view of the
relationships between costs, volume and profits.
It shows the break-even point and also indicates the estimated
profit or loss at various levels of output. The break-even point
as indicated in the chart is the point at which the total cost line
and the total sales line intersect.
There are three methods of drawing a break-even chart.
Illustration:
Let the following data be plotted on a break-even chart to determine :
(a) Break-even point
(b) Profit if the output is 25,000 units.
Output Variable Cost Total Fixed Total Selling Total
(Units) (per unit) Variable Expenses Cost Price Sales
(₹) Cost (₹) (₹) (perunit) (₹)
(₹) (₹)
0 5 0 75,000 75,000 10 0
5,000 5 25,000 75,000 1,00,000 10 50,000
10,000 5 50,000 75,000 1,25,000 10 1,00,000

15,000 5 75,000 75,000 1,50,000 10 1,50,000

20,000 5 1,00,000 75,000 1,75,000 10 2,00,000

25,000 5 1,25,000 75,000 2,00,000 10 2,50,000

30,000 5 1,50,000 75,000 2,25,000 10 3,00,000

Solution: First Method
Solution: Second Method
Here, the fixed cost line is drawn over and parallel to the
variable cost line. The fixed cost line, so drawn, represents the
total cost at various levels of output.

This method provides additional information:

(a) For each level of activity the variable costs are shown
directly.
(b) Marginal contribution at various levels of sales is clearly
indicated.
Solution: Third Method—Contribution Break-even Chart:
Under this method, instead of total cost line, the contribution
line is drawn from the origin and this line gradually increases
with the level of output.
The point of intersection of the contribution and the fixed cost
lines, is the Break-Even Point.

This chart clearly shows contribution at different levels of

activity and indicates that all levels below the break-even
point are unable to cover the fixed costs.
ADVANTAGES OF BREAK-EVEN CHARTS:
1) The management can understand more information from
the break-even chart than Profit and Loss Account and
Cost Statements.
2) The relationship between cost, volume and profit of the
company are simply presented in the break-even chart. It
summarizes maximum information in a graph.
3) The chart is highly useful for taking valuable decisions by
the management. The reason is that break-even chart
shows the effect on profits of changes in fixed costs,
variable costs, selling price and volume of sales.
4) The chart is very useful for forecasting costs and profits at
various levels of production and sales.
5) The management exercises the cost control because it
shows the relative importance of the fixed costs and the
variable cost.
6) The chart helps the management to find the profitability
of products and most profitable product mix.
7) Profits at different levels of activity can also be
ascertained.
8) The chart helps to fix the selling price, which would give
desired profit.
9) The effect of increase or reduction of selling price is
known in the chart.
LIMITATIONS OF BREAK-EVEN CHARTS:
1) A break-even chart is drawn on the basis of assumptions.
But, the assumptions does not hold good. The fixed costs
may vary beyond the certain level of operation. Likewise,
the variable costs do not vary in direct proportion of the
level of operation if the law of diminishing or increasing
return is applicable in the business.
2) In the break-even chart, both total cost line and the sales
line look straight lines. Since the assumptions do not hold
good, these lines have not been drawn in straight lines in
practice. It leads to several break-even points at different
levels of activity.
3) More often, a break-even chart presents only a static view of
the problem under consideration.
4) Only limited information is available from the break-even
chart.
6) A single break-even chart does not provide an opportunity
to study the effect of various product mixes on profits.
7) In the case of managerial decisions, capital employed is
taken into consideration. But, the break-even chart does
not consider the capital employed. Hence, the managerial
decisions can be a reliable one.
MARGIN OF SAFETY:
The excess of actual or budgeted sales over the break-even sales
is known as the margin of safety. It represents the amount by
which sales revenue can fall before a loss is incurred.
Thus,
Margin of Safety = Total Sales – Sales at Break-Even Point.
Say, actual present sales are ₹ 5,00,000 and the break-even sales
are ₹ 4,00,000, then margin of safety is equal to ₹ 1,00,000, i.e., ₹
(5,00,000 – 4,00,000).
Margin of Safety can also be expressed in percentage. In the
previous example, margin of safety in percentage can be
calculated as 1,00,000/5,00,000 × 100 = 20%
Margin of safety calculated in percentage is also known as
Margin of Safety Ratio and can be expressed as:
M.S. Ratio = M.S./Sales × 100
= Actual Sales – Sales at B. E. P./Sales × 100
Margin of safety can also be calculated with the help of the
following formula:
Margin of Safety (M/S) = Profit/P/V Ratio
This is so because margin of safety is the volume of sales
beyond break-even point and all sales above the break-even
point give some profit, which can be calculated as:
Profit = Margin of Safety × P/V ratio
or MoS.= Profit/P/V Ratio
The size of the margin of safety is an important indicator of
the strength of a business. The large margin of safety indicates
that the business is sound and even if there is a substantial fall
in sales, there will still be some profit. On the other hand,
small margin of safety indicates that position of the business
is very vulnerable and even a small decline in the sales would
adversely affect the profit of the business and may result into
losses.
ANGLE OF INCIDENCE:
The angle of incidence is the angle formed between the
intersecting point of the sales line and the total cost line. The
angle of incidence points out the profit earning capacity of a
business. A large angle of incidence indicates a high rate of
profit whereas, a small angle of incidence designate a low rate
of profit.
Usually, a large angle of incidence coupled with a high margin
of safety signifies the most favourable position of a business.
CURVILINEAR BREAK-EVEN ANALYSIS
(TWO BREAK-EVEN POINTS):
The marginal costing approach is based upon the basic
assumption that the cost-volume-profit relationship is linear
and selling price and variable cost per unit will remain constant
at all levels of activity. However, actually that is not true.
Moreover, to increase the sales volume some concessions in
price need to be offered to the customers. In the same manner,
variable cost per unit may also increase with the increase in
level of production due to operating inefficiencies and the law
of diminishing returns.
Thus, profit increases only upto a certain point and then
decreases to be converted into a loss. The break-even chart will
then become curvilinear instead of linear, yielding more than
one break-even point, one at a lower level of output and another
at a higher level of output.
In such a case, increase in output/sales volume beyond the
first break-even point will increase profit but increase in
volume beyond the second break-even point will result in loss.
The optimum level of output shall be reached at the point
where difference between the total revenue and the total cost
is the highest.