CC-4 Economics Analysis for Business Decisions

UNIT-3 Cost & Revenue Analysis

Explain Cost & Kinds of Costs?

In Economics there are 10 Types of
Costs. These are explained below:
1. Opportunity costs
2. Explicit costs
3. Implicit costs
4. Accounting costs
5. Economic costs
6. Business costs
7. Full costs
8. Fixed costs
9. Variable costs
10. Incremental costs

Opportunity Costs
Opportunity cost is also referred to as alternative cost. Organisations tend to utilise their limited
resources for the most productive alternative and forgo the income expected from the second-
best use of these resources.
Opportunity cost may be defined as the return from the second-best use of the firm’s limited
resources, which it forgoes in order to benefit from the best use of these resources.
Example: Let us assume that an organisation has a capital resource of 1,00,000 and two
alternative courses to choose from. It can either purchase a printing machine or photo copier,
both having a productive life span of 12 years.
The printing machine would yield an income of 30,000 per annum while the photocopier would
yield an income of 20, 000 per annum. An organisation that aims to maximise its profit would
use the available amount to purchase the printing machine and forgo the income expected from
the photo copier. Therefore, the opportunity cost in this case is the income forgone by the
organisation, i.e., 20, 000 per annum.
Explicit costs
Explicit costs, also referred to as actual costs, include those payments that the employer makes
to purchase or own the factors of production. These costs comprise payments for raw materials,
interest paid on loans, rent paid for leased building or machinery and taxes paid to the
government.
An explicit cost is one that has occurred and is clearly reported in accounting books as a separate
cost.

Example: if an organisation borrows a sum of 70,00,000 at an interest rate of 4% per year, the
interest cost of 2,80,000 per year would be an explicit cost for the organisation.

Implicit costs
Unlike explicit costs, there are certain other costs that cannot be reported as cash outlays in
accounting books. These costs are referred to as implicit costs. Opportunity costs are examples of
implicit cost borne by an organisation.

Example: An employee in an organisation takes a vacation to travel to his relative’s place. In

this case, the implicit costs borne by the employee would be the salary that the employee could
have earned if he/she had not taken the leave. Implicit costs are added to the explicit cost to
establish a true estimate of the cost of production. Implicit costs are also referred to as imputed
costs, implied costs or notional costs.
Accounting costs
Accounting costs include the financial expenditure incurred by a firm in acquiring inputs for the
production of a commodity. These expenditures include salaries/wages of labour, payment for
the purchase of raw materials and machinery, etc.

Accounting costs are recorded in the books of accounts of a firm and appear on the firm’s
income statement. Accounting costs include all explicit costs along with certain implicit costs of
an organisation.

Example: depreciation expenses (implicit cost) are included in the books of account as a firm’s
accounting costs.

Economic costs
Economic costs include the total cost of opting for one alternative over another.

The concept of economic costs is similar that of opportunity costs or implicit costs with the only
difference that economic costs include the accounting cost (or explicit cost) as well as the
opportunity cost (or implicit cost) incurred to carry out an action over the forgone action.

Example: if the economic cost of the employee in the above example would include his/her
week’s pay as well as the expense incurred on the vacation.
Business costs
Business costs include all the expenditures incurred to carry out a business. The concept of
business cost is similar to the explicit costs.

Business costs comprise all the payments and contractual obligations made by a business, added
to the book cost of depreciation of plant and equipment. These costs are used to calculate the
profit or loss made by a business, filing for income tax returns and other legal procedures.
Full costs
The full costs include business costs, opportunity costs, and normal profit. Full costs of an
organisation include cost of materials, labour and both variable and fixed manufacturing
overheads that are required to produce a commodity.

Fixed costs
Fixed costs refer to the costs borne by a firm that do not change with changes in the output level.
Even if the firm does not produce anything, its fixed costs would still remain the same.

Example: depreciation, administrative costs, rent of land and buildings, taxes, etc. are fixed
costs of a firm that remain unchanged even though the firm’s output changes. However, if the
time period under consideration is long enough to make alterations in the firm’s capacity, the
fixed costs may also vary.

Variable costs
Variable costs refer to the costs that are directly dependent on the output level of the firm. In
other words, variable costs vary with the changes in the volume or level of output.

Example: if an organisation increases its level of output, it would require more raw materials.
Cost of raw material is a variable cost for the firm.Other examples of variable costs are labour
expenses, maintenance costs of fixed assets, routine maintenance expenditure, etc. However, the
change in variable costs with changes in output level may not necessarily be in the same
proportion.

Incremental costs
Incremental costs involve the additional costs resulting due to a change in the nature of level of
business activity.

It characterises the additional cost that would have not been incurred if an additional unit was not
produced. As these costs may be avoided by avoiding the possible variation in the production,
they are also referred to as avoidable costs or escapable costs.

Example: if a production house has to run for additional two hours, the electricity consumed
during the extra hours is an additional cost to the production house. The incremental cost
comprises the variable costs.
Break Even Analysis: Meaning, Assumptions, Limitations & Determination of
Break Even Analysis.
A break-even analysis is a financial tool which helps a company to determine the stage at which
the company, or a new service or a product, will be profitable. In other words, it is a financial
calculation for determining the number of products or services a company should sell or provide
to cover its costs (particularly fixed costs).

Break-even is a situation where an organisation is neither making money nor losing money, but
all the costs have been covered.

Break-even analysis is useful in studying the relation between the variable cost, fixed cost and
revenue. Generally, a company with low fixed costs will have a low break-even point of sale. For
example, say Happy Ltd has fixed costs of Rs.10,000 vs Sad Ltd has fixed costs of Rs. 1,00,000
selling similar products, Happy Ltd will be able to break-even with the sale of lesser products as
compared to Sad Ltd.

Break-even analysis entails calculating and examining the margin of safety for an entity based
on the revenues collected and associated costs. In other words, the analysis shows how many
sales it takes to pay for the cost of doing business. Analyzing different price levels relating to
various levels of demand, the break-even analysis determines what level of sales are necessary
to cover the company's total fixed costs. A demand-side analysis would give a seller significant
insight into selling capabilities.
Break-even analysis is of vital importance in determining the practical application of cost func-
tions. It is a function of three factors, i.e. sales volume, cost and profit. It aims at classifying the
dynamic relationship existing between total cost and sale volume of a company.

Hence it is also known as “cost-volume-profit analysis”. It helps to know the operating condition
that exists when a company ‘breaks-even’, that is when sales reach a point equal to all expenses
incurred in attaining that level of sales. The break-even point may be defined as that level of
sales in which total revenues equal total costs and net income is equal to zero. This is also known
as no-profit no-loss point. This concept has been proved highly useful to the company executives
in profit forecasting and planning and also in examining the effect of alternative business
management decisions.

KEY TAKEAWAYS:

 Break-even analysis tells you how many units of a product must be sold to cover the
fixed and variable costs of production.
 The break-even point is considered a measure of the margin of safety.
 Break-even analysis is used broadly, from stock and options trading to corporate
budgeting for various projects.
Assumptions of Break-even Analysis.
The break-even analysis is based on the following set of assumptions:
(i) The total costs may be classified into fixed and variable costs. It ignores semi-variable cost.

(ii) The cost and revenue functions remain linear.

(iii) The price of the product is assumed to be constant.

(iv) The volume of sales and volume of production are equal.

(v) The fixed costs remain constant over the volume under consideration.

(vi) It assumes constant rate of increase in variable cost.

(vii) It assumes constant technology and no improvement in labour efficiency.

(viii) The price of the product is assumed to be constant.

(ix) The factor price remains unaltered.

(x) Changes in input prices are ruled out.

(xi) In the case of multi-product firm, the product mix is stable.

Limitations of Break-even Analysis.

We may now mention some important limitations which ought to be kept in mind while
using break-even analysis:

1. In the break-even analysis, we keep everything constant. The selling price is assumed to be
constant and the cost function is linear. In practice, it will not be so.

2. In the break-even analysis since we keep the function constant, we project the future with the
help of past functions. This is not correct.

3. The assumption that the cost-revenue-output relationship is linear is true only over a small
range of output. It is not an effective tool for long-range use.

4. Profits are a function of not only output, but also of other factors like technological change,
improvement in the art of management, etc., which have been overlooked in this analysis.
5. When break-even analysis is based on accounting data, as it usually happens, it may suffer
from various limitations of such data as neglect of imputed costs, arbitrary depreciation estimates
and inappropriate allocation of overheads. It can be sound and useful only if the firm in question
maintains a good accounting system.

6. Selling costs are especially difficult to handle break-even analysis. This is because changes in
selling costs are a cause and not a result of changes in output and sales.

7. The simple form of a break-even chart makes no provisions for taxes, particularly corporate
income tax.

8. It usually assumes that the price of the output is given. In other words, it assumes a horizontal
demand curve that is realistic under the conditions of perfect competition.

9. Matching cost with output imposes another limitation on break-even analysis. Cost in a
particular period need not be the result of the output in that period.

10. Because of so many restrictive assumptions underlying the technique, computation of a

breakeven point is considered an approximation rather than a reality.

Determination of Break-Even Analysis.

The formula for calculating the break-even point is

ВЕР – Total Fixed Cost/Contribution Margin Per Unit

Contribution margin per unit can be found out by deducting the average variable cost from the
selling price. So the formula will be

BEP = Total Fixed Cost/Selling Pr ice – AVC

Example:
Suppose the fixed cost of a factory in Rs. 10,000, the selling price is Rs. 4 and the average
variable cost is Rs. 2, so the break-even point would be

ВЕР = 10,000(4-2) = 5,000 units.

It means if the company makes the sales of 5,000 units, it would make neither loss nor profit.
This can be seen in the analysis.

Sales = Rs.20, 000

Cost of goods sold:

(a) Variable cost at Rs.2 = Rs. 10,000
(b) Fixed costs = Rs. 10,000

Total Cost = Rs. 20,000

Net Profit = Nil

ВЕР in term of Sales Value:

Multi-product firms are not in a position to measure the break-even point in terms of any
common unit of product. They find it convenient to determine the break-even point in terms of
total rupee sales. Here again the break-even point would be where the contribution margin (sales
value—variable costs) would be equal to fixed costs. The contribution margin however, is
expressed as a ratio to sales. The formula for calculating the break-even point is

BEP = Fixed Cost/Contribution Ratio

Contribution Ratio (CR) = Total Revenue (TR)-Total Variable Cost (TVC)/Total Revenue (TR)

For example, if TR is Rs. 600 and TVC is Rs. 450, then the contribution ratio is

CR = 600 – 450/600/600=150/ 600 = 0.25

The Contribution Ratio is 0.25

BEP = Total Fixed Cost /Contribution Ratio

= 150/0.25 = 600

The firm achieves its ВЕР when its sales are Rs. 600

Total Revenue = Rs.600

Total Cost = Rs.600

Net Profit/loss = Nil

Types of Break-Even Point:

The above paragraph explains a simple type of break-even point which is based on cost and
revenue i.e., the profit and loss break-even.

There are two other types of break-even and they are:

(i) Cash break-even, and

(ii) Income break-even.

(i) The Cash Break-Even:

An industry requires money for two purposes i.e., to acquire capital assets and to meet working
capital requirements. These requirements can be partly met by his own investment and partly by
loans and advances from financial institutions. The industry requires term loans to acquire capital
assets like land and building, plant and machinery.

In the case of term loans, the financial institutions shall have to find out the probability of the
applicant being able to meet the interest and loan repayment schedule. It will be more interested
in knowing the level of break-even point where not only total costs are required but also the full
debt service.

The level of break-even is called the cash break-even. It is based on revenue and cost data
involving cash flows. The depreciation, investment allowance reserve and other provision of the
cost items should be excluded but at the same time the repayment of installment should be added
to fixed cost.

Cash Break-Even Point = Fixed Cost+ Loan installment – Cash outflow/Contribution per unit

(ii) The Income Break-Even:

The various sources from which the industry is proposed to be financed such as the capital, long
term borrowing, deferred payments and other sources. If these sources are inadequate the
industry may approach the bank for under writing its shares. If the share market does not respond
positively, the equity risk falls on the underwriter.

As the share holder of the bank will expect a certain dividend just to cover the payment of
interest for the term loans. In order to calculate income break-even point the equity capital cash
earnings should be added. The income breakeven point can be calculated in the following
manner.

Income Break-Even Point = Fixed Cost + Earnings required for dividend/Contribution per unit

Multiple-product Firms and Break-Even Point:

The multiple products may differ in models, styles or sizes of their output. In the case of multi-
product firms the break-even point for each product can be calculated if the ‘product mix’ is
known. The product mix is the full list of products offered for sale by a Company. It may range
from one or two product lines to a combination of several product lines or groups.

Suppose an industry is engaged in the production of three items, namely X, Y, and Z. The
contribution for items is as follows:
X = Rs. 6 per unit

Y = Rs. 4 per unit

Z = Rs. 2 per unit

The product-mix given by the manufacturer is as follows:

X = 40,000 units
Y = 2, 00,000 units

Z = 1, 60,000 units.

Then the product-mix proportions are 1:5:4. We can work out the weighted average
contribution in the following way:
Product – Contribution x Unit Proportions – Total Contributions

X–6x1–6

Y – 4 x 5 – 20

Z–2x4–8

____ ____

10 – 34

Average Contribution per unit = 34/ 10 = Rs 3.4

BEP= Total Fixed Cost/ Average contribution per unit = 5, 10,000 / 3.4 = 1, 50,000 units

We will get the break-even output for all the three items by dividing the above figure in the same
proportion

X = 15,000

Y = 75,000

Z = 60,000

This reveals that the production manager has to ensure that production in the X line does not go
below 15,000 units, in the Y line 75,000 units and in the Z line 60,000 units. If not, he has to
sustain loss. The same method can be applied for computing the ВЕР in cases of multiple
product industries producing any number of items.
Uses of Break-Even Analysis in Managerial Economics
To the management, the utility of break-even analysis lies in the fact that it presents a
microscopic picture of the profit structure of a business enterprise. The break-even analysis not
only highlights the area of economic strength and weakness in the firm but also sharpens the
focus on certain leverages which can be operated upon to enhance its profitability.

It guides the management to take effective decision in the context of changes in government
policies of taxation and subsidies.

The break-even analysis can be used for the following purposes:

(i) Safety Margin:
The break-even chart helps the management to know at a glance the profits generated at the
various levels of sales. The safety margin refers to the extent to which the firm can afford a
decline before it starts incurring losses.

The formula to determine the sales safety margin is:

Safety Margin= (Sales – BEP)/ Sales x 100

From the numerical example at the level of 250 units of output and sales, the firm is earning
profit, the safety margin can be found out by applying the formula

Safety Margin = 250- 150 / 250 x 100 =40%

This means that the firm which is now selling 250 units of the product can afford to decline sales
upto 40 per cent. The margin of safety may be negative as well, if the firm is incurring any loss.
In that case, the percentage tells the extent of sales that should be increased in order to reach the
point where there will be no loss.

(ii) Target Profit:

The break-even analysis can be utilised for the purpose of calculating the volume of sales
necessary to achieve a target profit.

When a firm has some target profit, this analysis will help in finding out the extent of
increase in sales by using the following formula:
Target Sales Volume = Fixed Cost + Target Profit / Contribution Margin per unit

By way of illustration, we can take Table 1 given above. Suppose the firm fixes the profit as Rs.
100, then the volume of output and sales should be 250 units. Only at this level, it gets a profit of
Rs. 100. By using the formula, the same result will be obtained.

(iii) Change in Price:

The management is often faced with a problem of whether to reduce prices or not. Before taking
a decision on this question, the management will have to consider a profit. A reduction in price
leads to a reduction in the contribution margin.
This means that the volume of sales will have to be increased even to maintain the previous level
of profit. The higher the reduction in the contribution margin, the higher is the increase in sales
needed to ensure the previous profit.

The formula for determining the new volume of sales to maintain the same profit, given a
reduction in price, will be as follows:
New Sales Volume = Total Fixed Cost = Total Profit/ New Selling price – Average Variable
Cost

For example, suppose a firm has a fixed cost of Rs. 8,000 and the profit target is Rs.20, 000. If
the sales price is Rs.8 and the average variable cost is Rs. 4, then the total volume of sales should
be 7,000 units on the basis of the formula given under target price.

Suppose the firm decides to reduce the selling price from Rs.8 to Rs. 7, then the new sales
volume should be on the basis of the above formula:
New Sales Volume = 8,000 + 20,000/7-4 = 9,300

From this, we can infer that by reducing the price from Rs. 8 to Rs. 7, the firm has to increase the
sales from Rs. 7,000 to Rs 9,330 if it wants to maintain the target profit of Rs. 20,000. In the
same way, the sales executive can calculate the new volume of sales if it increases the price.

(iv) Change in Costs:

When costs undergo change, the selling price and the quantity produced and sold also undergo
changes.

Changes in cost can be in two ways:

(i) Change in variable cost, and

(ii) Change in fixed cost.

(i) Variable Cost Change:

An increase in variable costs leads to a reduction in the contribution margin. This reduction in
the contribution margin will shift the break-even point downward. Conversely, with the fall in
the proportion of variable costs, contribution margins increase and break-even point moves
upwards.

Under conditions of changing variable costs, the formula to determine the new quantity or
the new selling price is:
(a) New Quantity or Sales Volume = Contribution to Margin/ Present Selling Price – New
Variable Cost Per Unit

(b) New Selling Price = Present Sale Price +New Variable Cost-Present Variable Cost

Example:
The contribution margin is Rs. 64,000, the present sale price is Rs.10 and the present variable
cost is Rs.6. If the variable cost per unit goes up from Rs.6 to Rs. 7, what will be the new sales
volume and price?

New Sales Volume = 64,000/ 10-7 = 64,000 /3 = 21,300 units

New Sales Price = (10+7-6) = Rs. 11.

(ii) Fixed Cost Change:

An increase in fixed cost of a firm may be caused either due to a tax on assets or due to an
increase in remuneration of management, etc. It will increase the contribution margin and thus
push the break-even point upwards. Again to maintain the earlier level of profits, a new level of
sales volume or new price has to be found out.

New Sales Volume = Present Sale Volume +

(New Fixed Cost + Present Fixed Costs)/ (Present Selling Price-Present Variable Cost)

New Sale Price = Present Sale Price +

(New Fixed Costs – Present Fixed Costs)/ Present Sale Volume

Example:
The fixed cost of a firm increases from Rs. 5,000 to Rs. 6,000. The variable cost is Rs. 5 and the
sale price is Rs. 10 and the firm sells 1,000 units of the product

New Sales Volume = 1,000 + 6,000 – 5,000/ 10 – 5 =1,000 + 1,000/ 5 = 1,000 + 200=1,200 units

New Sale Price = 10 + 6,000 – 5,000/ 1,000 = 10 + 1,000/ 1,000= Rs.10 + Re1

= Rs. 11

(v) Decision on Choice of Technique of Production:

A firm has to decide about the most economical production process both at the planning and
expansion stages. There are many techniques available to produce a product. These techniques
will differ in terms of capacity and costs. The breakeven analysis is the most simple and helpful
in the case of decision on a choice of technique of production.

For example, for low levels of output, some conventional methods may be most probable as they
require minimum fixed cost. For high levels of output, only automatic machines may be most
profitable. By showing the cost of different alternative techniques at different levels of output,
the break-even analysis helps the decision of the choice among these techniques.

(vi) Make or Buy Decision:

Firms often have the option of making certain components or for purchasing them from outside
the concern. Break-even analysis can enable the firm to decide whether to make or buy.
Example:
A manufacturer of car buys a certain components at Rs. 20 each. In case he makes it himself, his
fixed and variable cost would be Rs. 24,000 and Rs.8 per component respectively.

BEP = Fixed Cost/ Purchase Price – Variable Cost

= 24,000/ 20-8 = 24,000/ 12 = 2,000 units

From this, we can infer that the manufacturer can produce the parts himself if he needs more than
2,000 units per year. However, certain considerations need to be taken account of in a buying
decision, such as

(i) Is the required quality of the product available?

(ii) Is the supply from the market certain and timely?

(iii) Do the supplies of the components try to take any monopoly advantage?

(vii) Plant Expansion Decisions:

The break-even analysis may be adopted to reveal the effect of an actual or proposed change in
operation condition. This may be illustrated by showing the impact of a proposed plant on
expansion on costs, volume and profits. Through the break-even analysis, it would be possible to
examine the various implications of this proposal.

Example:
A company has the capacity to produce goods worth of Rs. 40 crores a year. For this has incurred
a fixed cost of Rs 20 crores, the variable costs being 60% of the sales revenue. Now company is
planning to incur an additional Rs. 6 crores in feed costs to expand its production capacity from
Rs. 40 crores to Rs.60 crores. The survey shows that the firm’s sales can be increased from Rs.
40 crores to Rs. 50 crores. Should the firm go in for expansion?

ВЕР at present capacity = Fixed cost/ Margin Contribution% = Rs. 10 crores/ 40% =Rs25Crores

ВЕР at the proposed capacity = Rs 16 crores/40%= Rs 40 crores.

Increase in break-even point = Rs 40 crores-Rs. 25 crores = Rs. 15 crores.

Thus we can infer that the firm should go in for expansion only if its sales expand by more than
Rs. 15 crores from its earlier level of Rs. 40 crores.

(viii) Plant Shut Down Decisions:

In the shut down decisions, a distinction should be made between out of pocket and sunk costs.
Out of pocket costs include all the variable costs plus the fixe cost which do not vary with
output. Sunk fixed costs are the expenditures previously made but from which benefits still
remain to be obtained e.g. depreciation.
(ix) Advertising and Promotion Mix Decisions:
The main objective of advertisement is to stimulate or increase sales to all customers-former,
present and future. If there is keen to undertake vigorous campaign of advertisement. The
management has to examine those marketing activities that stimulate consumer purchasing and
dealer effectiveness.

The break-even point concept helps the management to know about the circumstances. It enables
him not only to take appropriate decision but by showing how these additional fixed cost would
influence BEPs. The advertisement pushes up the total cost curve by the amount of
advertisement expenditure.

(x) Decision Regarding Addition or Deletion of Product Line:

If a product has outlive utility in the market immediately, the production must be abandoned by
the management and examined what would be its consequent effect on revenue and cost.
Alternatively, the management may like to add a product to its existing product line because it
expects the product as a potential profit spinner. The break-even analysis helps in such a
decision.

Example:
A fan manufacturer possesses the following data regarding his firm:
Total Fixed Cost = Rs. 1, 50,000

Volume of Sales = 5, 00,000 units

The manufacturer is considering whether or not to drop heaters from its product line and replace
it with a fancy kind of fan.

He knows that if he takes the decision of dropping heaters and replaces it with fancy fans
his output and cost data would be:
Total Fixed Cost = Rs. 1, 50,000

Likely Volume of Sales = Rs. 5, 00,000

To find out the impact of proposed change, we need to compare profits in the two situations.
Firstly, we have to find out the contribution ratio of each product.

Therefore, the contribution ratio of the entire product line = 0.167+ 0.12+ 0.08 = 0.367

Total Contribution = Rs.5, 00, 00 × 0.367 = Rs 1,83,500

Profit = Total Contribution – Total Fixed Cost

= Rs. 1, 83,500 – Rs. 33,500.

We have to follow the similar analysis for the second situation:

Contribution Ratio of Ordinary Fans = 360 – 240/ 360 × 50a% = 0.167

Contribution Ratio of Exhaust Fans = 600 – 360/ 600 × 20% = 0.08

Contribution Ratio of Fancy Fans = 850 – 450/ 850 × 30% = 0.141

Thus the contribution ratio of the entire product line = 0.167+0.08+0.141 = 0.388.

Total Contribution =Rs. 5, 00,000 x 0.388=Rs. 1, 94,000

Profit= Rs. 1, 94,000— Rs. 1, 50,000=Rs 44,000

From the above analysis, we can infer that the manufacturer should drop heaters from his product
line and add fancy fens to his product line so as to earn more profit.
Problems of Break-Even Analysis.
Solved problems on Break even analysis - 1
Beta Associates has the following details:
Fixed cost = Rs. 40, 00,000;
Variable cost per unit = Rs. 200;
Selling price per unit = Rs. 400;
Find (a) The break-even sales quantity, (b) The break-even sales, (c) If the actual production
quantity is 60,000, find (i) contribution and (ii) margin of safety by all methods.

Given Data:
Fixed cost (FC) = Rs. 40,00,000
Variable cost per unit (v) = Rs.200
Selling price per unit (s) = Rs.400
Production quantity (Q) = 60,000

Formula used:

Contribution = Sales – Total Variable cost

M.S = Sales - Break-even sales
M.S = (Profit / Contribution) * sales
Profit = Sales – [Fixed cost + total variable cost]
M.S. as a per cent of sales = (M.S./Sales)*100
Solution:
(a) Break-even quantity = 40,00,000 / (400 – 200)
= 20,000 units

(b) Break-even sales = [40,00,000 / (400-200)] x 200

= Rs. 80,00,000

(c) (i) Contribution = Sales – Total variable cost

= (s x Q) – (v x Q)
= (400 x 60,000) – (200 x 60,000)
= 2,40,00,000 – 1,20,00,000
= Rs. 1,20,00,000

(ii) Margin of safety

Method I
M.S = Sales - Break-even sales
= (s x Q) – Break-even sales
= (400 x 60,000) - 80,00,000
= Rs. 1,60,00,000

Method II
Profit = Sales – [Fixed Cost + Total Variable Cost]
= (s*Q) – [FC + (v*Q)]
= (400 x 60,000) – [40,00,000 + (200 x 60,000)]
= 2,40,00,000 – 1,60,00,000
= Rs. 80,00,000

M.S = (Profit / Contribution) * sales

= (Profit / Contribution) * (s*Q)
= (80,00,000 / 1,20,00,000) x (400*60000)
= (0.666666666) x 2,40, 00,000
= Rs. 1,60,00,000

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

= (1,60,00,000 / 2,40,00,000) x 100
= 66.67%

Results:
(a) Break-even quantity = 20,000 units
(b) Break-even sales = Rs. 80,00,000
(c) (i) Contribution = Rs. 1,20,00,000
(ii) Margin of safety = Rs. 1,60,00,000 (Method I)
Margin of safety = Rs. 1,60,00,000 (Method II)
M.S. as a per cent of sales = 66.67%

Solved problems on Break even analysis - 2

Consider the following data of a company:
Sales = Rs. 40,000;
Fixed cost = Rs. 7500;
Variable cost = Rs. 17,500;
Find the following: (a) Contribution (b) Profit (c) BEP (d) M.S.

Given Data:
Sales = Rs. 40,000
Fixed cost = Rs. 7,500
Total variable cost = Rs.17,500

Formula Used:
Contribution = Sales – Total variable costs
Profit = Contribution - Fixed cost
BEP = Fixed cost / (P/V ratio)
P/V ratio = Contribution / sales
M.S. = Profit / (P/V ratio)
Solution:
(a) Contribution = Sales – Total variable costs
= Rs. 40,000 - Rs. 17,500
= Rs. 22,500

(b) Profit = Contribution - Fixed cost

= Rs. 22,500 - Rs. 7,500
= Rs. 15,000

(c) BEP = Fixed cost / (P/V ratio)

P/V ratio = Contribution / sales
= 22,500 / 40,000
= 0.5625
P/V ratio in percent = 0.5625 x 100 = 56.25%

BEP = 7,500 / 0.5625

= Rs. 13,333.33

(d) M.S. = Profit / (P/V ratio)

= 15,000 / 0.5625
= Rs. 26,666.67
Break-Even Analysis: Problem with Solution # 3.
From the following particulars, calculate:
(i) Break-even point in terms of sales value and in units.

(ii) Number of units that must be sold to earn a profit of Rs. 90,000.

Solution:
Break-Even Analysis: Problem with Solution # 4.
From the following data, you are required to calculate:
(a) P/V ratio

(b) Break-even sales with the help of P/V ratio.

(c) Sales required to earn a profit of Rs. 4,50,000

Fixed Expenses = Rs. 90,000

Variable Cost per unit:

Direct Material = Rs. 5

Direct Labour = Rs. 2

Direct Overheads = 100% of Direct Labour

Selling Price per unit = Rs. 12.

Solution:
Break-Even Analysis: Problem with Solution # 5.
From the following data, you are required to calculate break-even point and net sales value
at this point:

If sales are 10% and 25% above the break even volume, determine the net profits.

Solution:
Break-Even Analysis: Problem with Solution # 6.

From the following particulars, find out the break-even-point:

What should be the selling price per unit, if the break-even point should be brought down to
6,000 units?

Solution:
Break-Even Analysis: Problem with Solution # 7.

The fixed costs amount to Rs. 50,000 and the percentage of variable costs to sales is given to be
66 ⅔%.

If 100% capacity sales are Rs. 3,00,000, find out the break-even point and the percentage
sales when it occurred. Determine profit at 80% capacity:

Solution:
Break-Even Analysis: Problem with Solution # 8.

From the following information, ascertain by how much the value of sales must be
increased by the company to break-even:

Solution:
Break-Even Analysis: Problem with Solution # 9.
Calculate:
(i) The amount of fixed expenses.

(ii) The number of units to break-even.

(iii) The number of units to earn a profit of Rs. 40,000.

The selling price per unit can be assumed at Rs. 100.

The company sold in two successive periods 7,000 units and 9,000 units and has incurred a loss
of Rs. 10,000 and earned Rs. 10,000 as profit respectively.

Solution:
Break-Even Analysis: Problem with Solution # 10.
A company is making a loss of Rs. 40,000 and relevant information is as follows:
Sales Rs. 1,20,000; Variable Costs Rs. 60,000; Fixed costs Rs. 1,00,000.

Loss can be made good either by increasing the sales price or by increasing sales volume. What
are Break even sales if

(a) Present sales level is maintained and the selling price is increased.

(b) If present selling price is maintained and the sales volume is increased. What would be sales
if a profit of Rs. 1,00,000 is required ?

Solution: