5 - Break-Even Analysis

Break even analysis
Break-even point
• The break-even point (BEP) in economics is
the point at which total cost and total revenue
are equal: there is no net loss or gain.
• It indicates the minimum level of production
for business to be viable.
• The main objective of break-even analysis is to
find the cut-off production volume from
where a firm will make profit.
Break- even analysis graph
Break-even point calculation
Let:
• s = selling price per unit
v = variable cost per unit
FC = fixed cost per period
Q = volume of production
• The total sales revenue (S) of the firm is given by the
following formula: S = s xQ
• The total cost of the firm for a given production volume
is given as
• TC = Total variable cost + Fixed cost = v x Q + FC
Break-even point calculation (contd)
• The formulae to find the break-even quantity
and break-even sales quantity:
• Break-even quantity = Fixed cost / (Selling
price/unit - Variable cost/unit )
• Break-even sales (in RS.) = Break-even quantity
xs
Contribution
• The contribution is the difference between the
sales and the variable costs.
• Contribution =Actual Sales – Actual Variable
costs
• Contribution/unit =
Selling price/unit – Variable cost/unit
Margin of safety
• The margin of safety (M.S.) is the sales over
and above the break-even sales. The formulae
to compute these values are
• M.S. = Actual sales – Break-even sales

= (Profit / Contribution)x sales
• M.S. as a per cent of sales = (M.S./Sales)x 100

Example 1
• Krishna Company Ltd. has the following details:
Fixed cost = Rs. 40,00,000; Variable cost per unit =
Rs. 300; Selling price per unit (s) = Rs. 500
Find
(a) The break-even sales quantity (b) The break-even
sales
(c) If the actual production quantity is 1,20,000, find
the following:
(i) Contribution (ii) Margin of safety
Solution 1
(a) Break-even quantity = Fixed cost / (Selling
price/unit - Variable cost/unit )
= 40,00,000/ (500-300)
= 20000 units
(b) Break-even sales (in RS.) = Break-even
quantity x s
= 20,000 x 500 = Rs. 1,00,00000
Solution 1 continued
(c)(i) Contibution=
Actual Sales – Actual Variable costs
= 120000x (500-300)
= 120000 x 200
= Rs. 24000000
ii) Margin of safety = Actual sales – break even sales

= (120000x500) - Rs. 1,00,00000
=Rs. 50000000
Example 2
• The following data relates to ABC Co. for 2011 :
Fixed Factory Overhead = Rs. 30,000
Fixed Selling Overheads = Rs. 6,000
Variable Manufacturing Cost per unit = Rs. 6.00
Variable Selling Cost per unit = Rs. 1.50
Selling Price Per unit = Rs. 12.00
Calculate
i) Break even point in terms of units and BE sales in terms of
rupees.
ii) Number of units that need to be sold to make a profit of Rs.
45,000.
solution 2
Fixed cost = Fixed Factory + Fixed Selling Overheads
= 30,000+ 6000 =Rs. 36,000.
Variable cost per unit = Variable Manufacturing Cost
per unit+ Variable Selling Cost per unit =6+1.5
= Rs. 7.5
Selling Price Per unit = Rs. 12.00
i) Break – even quantity = FC/ (SP per unit- VC per
unit) =36,000/(12-7.5) = 36,000/4.5 = 8000 units.
Break even revenue = 8000 x 12 = Rs. 96,000

Solution 2 (contd)
• Let required quantity = q.
• Profit = 45,000
TR – TC = 45,000
S.P per unit x q – (FC +VC) = 45,000
12q – 36,000 – 7.5 q = 45,000
4.5 q = 45000+ 36000 = 81000
q = 81,000/4.5 = 18000 units.
PROFIT/VOLUME RATIO (P/V RATIO)
• P/V ratio is a valid ratio which is useful for further

analysis. The different formulae for the P/V ratio are
as follows:
• P/V ratio =( Contribution /Sales) x 100
• The relationship between BEP and P/V ratio is as
follows:
• BEP = Fixed cost / P/V ratio
• The following formula helps us find the M.S. using the
P/V ratio:
• M.S. = Profit / P/V ratio
Example 3
• Consider the following data of a company for
the year 1998:
• Sales = Rs. 80,000 Fixed cost = Rs. 15,000
Variable cost =Rs. 35,000
• Find the following:
• (a) Contribution (b) Profit (c) BEP (d) M.S.
Solution 3
(a) Contribution = Sales – Variable costs = Rs. 80,000 – Rs.
35,000 = Rs. 45,000
(b) Profit = Contribution – Fixed cost = Rs. 45,000 – Rs.
15,000 = Rs. 30,000
(c) BEP:
• P/V ratio = Contribution /Sales
= (45,000 / 80,000 ) x 100 = 56.25%
• BEP = Fixed cost /P/V ratio
= (15000/ 56.25 ) x 100= Rs. 26,667
(d) M.S. = Profit / PV ratio= Rs. 53,333.33
Example 4
The following data is obtained from the records
of a factory:
• Sales = Rs. 2,00,000
• Raw materials consumed = Rs. 60,000
• Labour charges= Rs. 40,000
• Fixed overhead = rs. 25,000
• Variable overhead = rs. 20,000
Calculate BEP in terms of rupees.
Solution 4
• Contribution =Sales – VC= 2,00,000 – 1,20,000
= Rs. 80,000
• P/V ratio = Contribution/ Sales =
80,000/2,00,000 = 0.4
• BEP in terms of rupees =FC/ PV RATIO
= 25,000/0.4 = Rs. 62,500
Example 5
• A manufacturer of TV buys TV cabinet at Rs.
500 each. In case the company makes it within
the factory, the fixed and variable costs would
be Rs. 4,00,000 and Rs. 300 per cabinet
respectively. Should the manufacturer make
or buy the cabinet if the demand is 1,500 TV
cabinets?.
Solution 5
Solution:
• Selling price/unit (SP) = Rs. 500
• Variable cost/unit (VC) = Rs. 300
• Fixed cost (FC) = Rs. 4,00,000
• BEP = 400000/ ( 500 – 300) = 2,000 units
• Since the demand (1,500 units) is less than the
break-even quantity, the company should buy
the cabinets for its TV production, rather than
make it.

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Break even analysis

• M.S. = Actual sales – Break-even sales

• M.S. as a per cent of sales = (M.S./Sales)x 100

ii) Margin of safety = Actual sales – break even sales

Break even revenue = 8000 x 12 = Rs. 96,000

• P/V ratio is a valid ratio which is useful for further

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