COST-VOLUME-PROFIT ~~” ANALYSIS Break-even Analysis Introduction; Meaning of CVP analysis; Break-even analysis; Assumptions; Contribution and marginal cost equation; P/V ratio; Calculations in break- even analysis; Margin of safety; Key factor; Angle of incidence; Break-even chart; Profit volume chart; Uses and limitations of Break-even analysis; Summéry of formulae; Problems and solutions; Key terms; Examination questions. iuction, chapter. CVP analysis follows directly from variable co and applied in variable costing are applicable here. company must eam profits to stay in business. CYP Managers make various plans to incre: 2 will be affected if an additional sales promotional expenditu: 0,000 units? Similarly, how many units of product shoul! 92° If company sells 1,50,000 units, what will be the emouty & Similar questions find their answers in the stedy LUME-PROFIT ANALYSIS ofit planning. [It studies the cosT-Vo! CLE analysis is a powerful tool of Pr ctors of business operatio! '©) Cost of production, °) Volume of production/sales, and ‘9 Profit. hee se thiee factors are inter-connected in such 3 "39 os “1s of cause and effect relationship amongst thea. & 4 price and the selling price determines the level of Pr e of sales which disectly affects the volume of P stction results in changes in cont of the effects on future profies: ng hy, mix.” ha, to management in budgetin e net profit : 1, yarlations in vote of pro I eye analysis a “the such ates price, quancity a” extremely useful he following on Ul influences cost, In brie! CIMA London hax defin in fixed cost, variable cost, An understanding of CUP anal planning, It explains the impact of ¢ (a) Changes in selling prices, (b) Changes in volume of sales, (c) Changes in variable © (a) Changes in fixed cost. Infact, CVP analysis helps in dete! factors on the remaining factors. BREAK-EVEN ANALYSIS a widely used technique to study the CVP relationship. It is interprey 19 ang | mining the probable effect of change in any one Of ty Break-even analysis is in nattow as well as broad sense. Narrow meaning. In its narrow sense, break-even analysis is concerned with detemin break-even point, ie., that level of production and sales where there is no profit and no lx At this point total cost is equal to total sales revenue. ee Broad meaning. When used in broad sense, break-even analysis is used to determine probs profit/loss at any given level of production/sales. It also helps to determine the amount « volume of sales to earn a desired amount of profit. Assumptions underlying Break-even Analysis and CVP Analysis The break-even analysis is based on the following eight assumptions : 1. All costs can be separated into fixed and variable components, 2. Variable cost per unit remains consti ant i Hgts $0 ha Volaim af protection, and total variable cost varies in direct propottict 3. Total fixed cost remains constant. 4, Selling price per unit does not change as volume changes 5. There i 5. These is only one product or in the case of multiple products, the sales mix does ™ change. In other words, when h ; ; several i ml avys bein some predetermined propoton, ond Sot the sale of varius Pa 6. There is synchronisation bet ‘i equals volume of gales, MOduction and sales. In other words, volume of produ? 7, Productivity per worker doe: : # Not change, 8, There will be no change in the deneral price level,” Contribution and Marginal Cost Equation a ‘As stated earlier, contsibution js the gj of sales, 1 is also Known as: cont teteRCe btw it) calculated by the following format" Margin (Gy) gg eat the marginal i t in toss margin, Thus contr | Contaibution » Sates eS ~ Variable co, st (Cage 9 me| ay Analysis (Break-even Analysts _proft Anal ae ir 53 | Contribution = Fixed co so. A st + Profit : a Contribution = Fixed cost - Loss | oa . wing marginal di from this the follwing Reema eau 4 [s-v=F+P | | ay tee of the above Four factors inthe equation are known, the fe il ¥ . mye, Thus : fourth one can be easily Sales = 7 12,000 variable cost = = 7,000 Fixed cost = % 4,000 ‘thus = C=S-V C = 12,000 - 7,000 = = 5,000 P=C-F P = 5,000 - 4,000 = = 1,000 Thus profit is € 1,000. ifs figure is not given but contribution is given then sales can be determined as follows : S=C+V S = 5,000 + 7,000 = = 12,000 hen fixed cost (F) is not given but profit is given, then : Fel=P F =5,000 - 1,000 = & 4,000 en variable cost (V) is not given, then VeS-C V = 12,000 - 5,000 = = 7,000 The concept of contribution is extremely helpful in the study of break-even analysis and Calculate on cenai “ulate contribution in each of the following independent situations : im ie cost & 8,000, profit € 5,600 eriable cost % 7,000, sales € 11,000 Contribution per unit & 7, profit & 3,000, B.E, Point 2,000 units. 0 ) ¢ “ntribution » Fixed cost + Profit = 8,000 + 5,600 = € 13,600 f | pe5.6 = Contribution = Sales - Variable cost a * T pn.000 - 7.000 = € 4,000 tion per unit) + Profit . , int (units) = Contsib (ii) Contribution aa a 3,000 = & 17,000 PROFIT-VOLUME RATIO (P/V RATIO) The profit/volume ratio, better known as contribution/sales ratio (C/S ratio), empress ty pro! . te relation of contribution to sales. Contribution _ C Symbolically, P/V ratio= “= 5 Oy wanspeton, weave () C= 5 P/V ratio c PWV ratio (ii) S= Example: Sales = % 10,000 Variable cost = % 8,000 C_s-v 10,000-8,000 2,000 Then P/V ratio = = 10,000 10,000 10 When expressed in Percentage, When P/V ratio is given, the contribution can be quickly calculated from any given level sales. In the above example, if only sales and P/V ratio were gi @s under; ven, contribution can be calculated 2 P/V ratio = => x 100 = C= Sx P/V ratio £10,000 x 20% Shange in contribution P/V ratio = “JE contribution Change i 1) Change in saleg = ige in profit Example : Change in sates Year Sales i, : 2d ci 22,00 1,000 P/V nitto-« oes es * 348001,000 st 22,009 20.000 * 100 a 2009 * 100 30%,rr _profit Analysis (Break-even Analysis) ratio in each of the following i i 2 uate cost & 60, Contribution & 40 ng independent situations () ates € 20, variable cost & 15 | (Feo of variable cost to sales 84% : i profit € 5,000; Sales % 25,000; Fixed Cost % 8,000 W) Yeat 1 Sales ¥ 50,000, Total cost & 40,000, Year II Sales € 60,000, Total cost % 45,000 jon ._ Contribution Contribution 40 0 : ratio= Contbuton | —_ 40 orn Sales Variable cost + Contribution “60+40 " too “ “7% : _._ Contribution 2-155 : ratio= Contztbution | ee aR Sales S72 72 "7% {i P/V ratio= 100 Variable cost to sales ratio = 100 - 84% = 16%. Contribution _F+P _ 5,000+8,000 _ 13,000 | 13 > tj) PMV ratio= SE . wen Sales s 25,000 25,000" 25 4 Change in profit* __ 15,000 - 10,000 5,000 = Gy pv ratio= CRaNSe in profit ® _ 15,000 70,000 000 = 50% we Change in sales ~ 60,000 - 50,000 ~ 10,000 . “Profit is the difference between sales and total cost. of P/V ratio B/Y mtio is one of the most important ratios to watch in business. It is an indicator of the rate E rhich profit is being eared. A high P/V ratio indicates high profitability and a low ratio icates low profitability in the business. The profitability of different sections of the business Bch 2s sales areas, classes of customers, product lines, methods of production, etc., may also -conpared with the help of profit-volume ratio, The P/V ratio is also used in making the g type of calculations: 4 (c)Calculation of break-even point. (©) Glculation of profit at a given level of sales. 8 Calculation of the volume of sales required to eam a given profit. : (etation of profit when margin of safety is given. oo * aaation Sr ne tune of sales required to svantain the presen level of prot if sling Price reduced, Movement in P/V Ratio P/V ratio « Yatlo indicates the rate of profitability. ost would result in higher profits. As @ any improvement in this ratio without increase avn by rote of caution, erroneous conclusions #25 be by 2 tuere reference to P/V ratio, Therefore, this ratio should not be used in isolation. ine is the function of sales and variable cost. Thus, it can be improved by widening the 0} Inet sales and variable cost. This can be achieved by : (hy peacasing the selling price ‘ueing the variable costss Management Ai (©) Changing the sales mix, i.e., selling more of those products which have larger p/y iti, : improving the overall P/V ratio. ther, 5.6 METHODS OF BREAK-EVEN ANALYSIS Break-even analysis may be performed by the following two methods : {@) Algebraic calculations (0) Graphic presentation Algebraic Method (Calculations in Break-even Analysis) i int i f output or sales at which t Break-even point. The break-even point is the volume o! OF which total eng is exactly equal to sales. It is a point of no profit and no loss. This is the minimum point tf Production at which total cost is recovered and after this point profit begins. ‘The fundamental formula to calculate break-even point is : = Total fixed cost —_—*F Sreakceven point (in units) ~ Contribution per unit. ~ S—v ae Total fixed cost | 5 14. FS Break-even point (in Rupees) ~ Contin * Stet = SS Total fixed cost or Break-even point (in Rupees) = pies Example Following data is given: Total fixed cost = % 12,000 Selling price = © 12 per unit Variable cost = 29 per unit Thus : Contribution sy = 12-9=%3 per unit rt 3 P/V ratio = =x1l =—— = /¥ rat 37100 == x100 = 25% Break-even point (in units) = Fixed cost 12,000 ; Contribution me = 121000 | Contribution per unit = 3 4,000 units. i Total fixed cost Break-even point (in?) mein)” “Gemmtatier * Soler : . 12,000 7 *12™ & 48,000 Also, ual Fixed cosy Bieak-even point (in®) . § 12,000 25% = 48,000pot anys (Break-even Analyte io" : ie ayer point may be verified as follows : er qotal cost ~ fixed cost + Variable cost otal cost = & 12,000 + (4,000 units x = © 48,000 a) aos vale and total cost at break-even point are exactly equal. y10NAL CALCULATIONS: the calculation of break-even point, the above formula can also be used in iditional calculations. These are : vr tation of profit at different sales volumes, + ation of sales fo desied profit, rinding missing figures. yy ation (0 jag conta a le fallowing data is given : = © 12,000 (total) = © 412 per unit = &9 per unit e the Sofution of Profit at different Sales Volumes will be the profit when sales are (a) € 60,000 (b) & 1,00,000 ? og : sR {) When sales = & 60,000 Contribution = Sales x P/V ratio = & 60,000 x 25% = © 15,000 Profit = Contribution - Fixed cost ' = & 15,000 - & 12,000 = & 3,000 {0 When sales = © 1,00,000 Contribution = % 1,00,000 x 25% = © 25,000 Prete = & 25,000 ~ & 12,000 = © 13,000. ‘ou of Sales for Desired Profits Fesiting the same figures, what willbe the ammount of sales if i is desired to earn a profit £.000; (b) & 15,000 ? P/V ratio = = 25% Sales for desired profit = FHS! cot Das profit . ©42.000 + & 6,000 Boo tee teCalculation of Missing figures Example : ‘ Given: Break-even point ~ & 30,000 Profit = © 1,500 Fixed cost = © 6,000 fi ot? What is the amount of variable cost ? Solution Fixed cost + profit Contribution 4 r5.000 + ® 500 = & 7,500 Break-even point = Ly Sales zt - les % 30,000 = 7599 Sa 10 Sales = a x 30,000 = % 37,500 _ _ Contribution 7,500 PV ratio = SATE x 100 = 37,599 * 100 = 20% Variable cost = 100 - P/V ratio Variable cost = 100 - 20% = 80% (of sales) Variable cost (80% of sales) = & 37,500 x 80% = & 30,000 Variable cost at break-even sales = € 30,000 x 80% = & 24,000 Also, variable cost at Break-even sales = % 30,000 - Fixed cost = % 30,000 ~ 6,000 = & 24,000. Example : Sales = 4,000 units @ % 10 per unit Break-even point = 1,500 units Fixed cost = 7 3,000 What is the amount of (a) variable cost; and (b) profit ? Solution Fixed cost Contribution per unit Break-even point (in units) = 1,500 » 7—— Contribution per unit « >= is per unit’ 7560 units ~ © 2 = Selling price ~ contuibution #210 ~% 2688 per unit - 4000 units x & 2 & 2,000 + Contribution ~ Fixed cost % 8,000 - & 3,000 = & 5,000. (a) Variable cost Contribution at sales Of 4,000 units (b) ProfitGiven? Fized cost x" aes Profit earned ‘arr 4 Break-even sales 2 40,000 what is the actual sales ? Sgolation contribution at break-even point is equal to fized cost. Cf 8000 | Thus, P/V ratio = Say cm Fixed con + Actual Sales = ee cant * Profit PLY ratio $,000+2,000 10,000 20% * Soy = = 50,000 Selling price -% 150 per unit Variable cost -% 90 per unit Fixed cost - & 6,00,000 (total) What is the break-even point? | What is the selling price per unit if break-even point is 12,000 exits? Fixed cost Contribution per writ _ $,00,000 _ 600.000 3 O09 unt Break-even point = 150-90 a . 7 ‘When break-even point is 12,000 units, contribution is caleulated 2s under = 6,00,000 12,000 = Con 7 7 600,000 £50 Contribution = T5500 units ~ gusey 50=S- 90 S= 50+ 90 $= 8 140 fee et } telling price is 2 140 when break-even point is 12.000 uni ston 53 * following information is given : Sales = © 2,00,000 Variable cot © 1.20.00 Fiaed cos = t 10,00S20 Calculate (2) ® © F i (@)_ New break-even point if fixed cost Increases dy 10% (Room, Rado; Solution 00, 000. BA ratio = A) (e)Break-even point (@)When selling price in reduced by 10%, new sales = 2,00,000 = 10% = & 1,80,000 1,80,000-1.20,000 __60,000 3 — ~ ~~ysa000 «180,000 3 F___ 30,000 New Break-even point - FP as 7 F 90.000 (c) When variable cost increases by 10%, new variable cost = 1,20,000 + 10% = & 1,32,000 2,00,000-1,32,000 _ _68,000 “200,000 200,000 * 200 = 34% 30,000 34% (C)E Sized cost increases by 10%, new fixed cost = 30,000 + 10% = ¥ 33,000 P/V ratio remains unaffected at 40% 33,000 New Bi i = = reak-even point Gm 7 © 82,500, Hnstration 5.4 From the following particulars, find out the selling price per unit if BLE, Point is to be bows! down to 9,000 units : New P/V ratio New Break-even point = = € 88,235 (Approx). Variable cost per unit = 5 Fixed expenses = 2,70,000 Selling price per unit =% 199 (Reon Solution Break-even point « ied cost Contribution per unit 2,170,000 000 units = — — 9-00 1 Contribution per unit 2,70,000 Contribution per unit = = = € 30,given the following data : ried expenses © 4,000 reak-even point & 10,000 you ate calculate— (iyP/V ratio (ii) Profit when sales are T 20,000 {ii New break-even point if selling price is reduced by 20% (B.Com., Dethi) .Com., Delhi ition break-even point, contribution is equal to fixed cost th zg \us when sal ak ‘ ales are & 10,000, i c 4,000 i) P/V ratio 5 = og * 100 = 40% (ii) When sales are & 20,000, contribution will be— 20,000 x 40% = 8,000 Profit = Contribution - Fixed cost = 8,000 - 4,000 = % 4,000 {i) New break-even point when selling price is reduced by 20%. ‘New sales figure = 20,000 - 20% = % 16,000 Variable cost = 12,000 Contribution = 16,000 - 12,000 = % 4,000 4,000, New P/V ratio = = 37 i600 7 2% —F _ , 4.000 _ = 16,000. PVratio ~ 25% New Break-even point = Break-even point "n break-even point is calculated only with those fixed costs which are payable in cash, 4 break-even point is known as cash break-even point. This means that depreciation and ea fixed costs are excluded from the fixed costs in computing cash break-even point. mula ig — Cash by a2 Cash fe ots ’ "eal even point = =--tration per unt MARGIN OF SAFETY (M/S) 30 of safety i hie difference between actual sales and sales at break-even nother wordy aepined 3s My whieh actual volume of sales exceeds the break-evenwe 6 or as a perc point, Margin of ately may be expressed in absolute money terms POCRRE Fay Thus, me! u/s. = Actual salon ~ Break-even point | Example Company X Company ¥ ‘Actual salon z a ton Loss: Mreakseven point = _ 40,00 0,000 Margin of aatoty z 20,000 20,000 Margin of safety as a % of sales “420,000 “ 100 * 0,000 * 100 ne a __ 783% “337% ‘The size of the margin of safety indicates soundness of a business, When margin of safety is large, it means the business can still make profits after a serious fall in sales, In such a situation, the business stands better chance of survival in times of depression. A large margin of safety usually indicates low fixed costs, When margin of safety is low, any loss of sales may be a matter of @ serious concem, Margin of safety is directly related to profit. This is shown below : | Profit ~ Margin of safety x Profit/volume ratio | P= M/S x P/V ratio thus | ™S~ D7V ratio If profit is 10% and P/V ratio is 40%, then 10% | M/s = TE = 25% i When actual sales are given— Profit = M/S ratio x P/V ratio x Actual sales When profit js not known but M/S is known, then Pe M/S * P/V ratio Pm 25% % 40% = 10% pee 18 Contribution per When margin of salety te not satisfactory, the f it i oll improve {a) Increave:the volume of sales, (4) Ines lowing steps may be taken to impro' @ ; ‘ease the sellin 1d cost Reduce variable cov, (¢) Improve sale Selling price, (c) Reduce fixe toies * tux by increasing the sales’of products with target 2A The effect of a price reduction it alwa, aera in nee a of wofety, %4 0 reduce B/¥ ratio, raise the breakeven poitt Also | M/S in units aitjv ratio = 100 - 70% » 904, ea ee oft argin of 87 = PTY ate = Ei)" © 30,009 40% * € 1,00,0009 Margin of safety 4,¢ Aatual 816 = Havgin of salelye ” poy = © 600,000 pe Point = Actual sales ~ Margin of safety = 5,00,000 = 1,00,000 = © 4,00,009 yesification Profit = Actual sales » M/s ratio » P/V ratio € 30,000 = 5,00,000 * 20% 30% {ii) BE Point = Actual sales ~ Margin of safety » % 4,00,000 ~ 70,000 » & 3,30,000 (vii) BE Point = Actual sales ~ Margin of safety = 10,000 units ~ 2,500 unite « 7,500 units ration 5.9 " (i) Margin of safety % 15,000; Fixed cost % 25,000; P/V ratio 30%, _ Also calculate profit in this case, (ii) BE Point % 40,000; P/V ratio 40%; Profit % 10,000, ii) Margin of safety 40%; Profit % 30,000, ) Contribution= (M/s in & x P/V ratio) + Fixed cost = (2 15,000 x 30%) + 25,000 = & 29,500 Profit = M/S x P/V ratia = & 15,000 x 30% ~ © 4,500 Or Profit = ¢ - F = % 29,500 - 25,000 = & 4,500 !) Contributions (BE Point x P/V ratio) + Profit » (40,000 x 40%) + 10,000 ~ © 26,000 i © 30,000 © 75,000 Hii) Contributions = Profit : a x On” Siargin of safely no” 40% P) Contribution» (BE Point » P/V ratio) + Profit Sei » (® 1,00,000 x 40%) + € 50,000 = © WS i Ah ) ontivatione (Margin of safety in units * aes | ’ + (4000 units « & 3) + € 30,000» © 42 r cases i biotin each of the following dndependent 6 j yattt Post ® 37,000; Contribution € 84.000. ,, Sales & 1,00,000. ‘Mable cost gow of gales, Margin of safety ratio 30%, Sale’wee (iii) Fixed cost % 2,00,000; Margin of safety 50%, P/V ratio 40% (iv) Margin of safety € 70,000, Variable cost ratio to sales 35% (v) Actual sales % 80,000; P/V ratio 20%, Fixed cost € 10,000. olution (i) Contribution= Fixed cost + Profit 84,000 = 37,000 + Profit Profit = 84,000 - 37,000 = % 47,000 (ii) P/V ratio = 100 - 80% = 20% Profit = Sales x M/S ratio x P/V ratio = 1,00,000 * 30% x 20% = & 6,000 i 00,000 (iii) BE Point = Fixed.cost. _ 2,00 % 5,00,000 P/Vratio 40% _ _ Margin of safety Margin of safety Margin of safety ratio = Suppose Margin of safety = x i X% = ——~__ 00,000 + x x 50% = 500,000 + x x = 0.50 (5,00,000 + x) 2,50,000 + 0.5x 2,50,000 % 5,00,000 Thus margin of safety = % 5,00,000 Profit = Margin of safety x P/V ratio = 5,00,000 x 40% = % 2,00,000 Verification Actual sales = BE Point + Margin of safety = 5,00,000 + 5,00,000 = % 10,00,000 Profit = Actual sales x M/S ratio x P/V ratio = 10,00,000 x 50% * 40% = & 2,00,000 (iv) P/V ratio = 100 - 35% = 65% 0.5x x 1 Profit = Margin of safety x P/V ratio * 70,000 » 65% = & 45,500 () Profit = Contribution ~ Fixed cost » (Actual sales « P/V ratio) - Fixed cost ™ (80,000 x 20%) - 10,000 « & 6,000 te, ‘Actual sales “BE Point + Margin of safetyWHE POR * FY pain ee OY TA Cnpneny silage TE «© NOM O Sales 6 17% oh CayRnity © ONIN 1 19% © FLAG beds » (hhes 7 9/9 watitg) « Fire 1008 OMS 1 tty SMA CA RAS | ay VM, th © 0 (ij E/V Aw ‘in + thiw Whit ‘ LL Margin A eatety « 19 tie Dives cn ~ Cantiiistion - Woh? SOMA BLD EULS Fehr Ht og g imo - “YUNA Mt Pofe V/V” hs Fatt MN Wit, (OTN the es” Sate Fires urd. + Heh. UMS * TUS ig § . a 2A eaten V/V is (A) 9/9 tI A = Os» 1ft Rawal even tiles = © OLNLYD » Why © 2420) Fireh ore, ME Phe Fry Vines cast = treayownen Yhte 7 O/T hip 21 M0NN 1 Us = € 24,009 LIMITING O% KEL rectOR ‘The objective A & business is to earn sarhta GuHih, Hermon it is net abmeys wae tds Objective because writ casing hs affected by 2 vatiery A tectens, For example, an xian n hand, ample skilled labour and production capact , ; Taal iatesal it needs for the manufectoze of marina Ga which could be sold. Thus, material is the tactor hich limits the size of output and peer ani undertaking from sarimising its WOit. Sirailany, sometimes 4 business is not able w et E that it can produce. In such a (awe, sales is the limiting factor, 4 Unaiting o7 key Sector may thus be defined as the factor itis sade which ot a particulor point in time o f ee oa 1 Over a period will limit is Umtiting Sectors are : pe mit the volume of output. Exp Sales (ii) Materials fit) Laborer of particular skill (i) Production ca ty oF (A) Virvancial resources, hachine heats5.19 f the ti 19 factor te ie purpose oF ctor technique is to indi x uch cases where alternatives are posse, ‘0 indicate the most Profitable course of action bution ner unit of Key factor) When a key facto as Maxi Fat | hed wheit Contribution i * perating, the most profitable peition is reac! u Per unit of key factor is mayi . profitable ies betwee producing produc A which yielas = conti nation of Te ree aaa choice ih eds @ contribution of € 20 per unit, product Penge more pian Mepduct. if, however, product A takes 3 kg., of material (which is a limiting factor) and product B tak the respective contributions per kg. of materat neat traps Product A= 215+ 3 kg 2&5 2 Product B= 2045 kg. = 2% mduct A, which gives the greater contribution in terms of per unit of limiting factor will be profitable. " The following data at is given : . Product A Product & Direct materials: e wu 14 Direct labour @ & 3 per hour z 6 9 Variable overhead @ & 4 per hour © 3 12 Selling price = 100 110 . Standard time 2 hrs, Bhs. _ State which product you would recommend to manufacture when : (c) Labour time is the key factor (®) Sales value is the key factor. Product A Product 3 f e Selling price (5) 100 Duect material * | Brect labour Wetiable overhead 7 Neriable cost wm = a en tz as Ves hs fe) + nttibution per labour hour cage eer = % 62+ 100 = 275+ 110 Contribution per rupee of sales value of al Vi) Product 4 is recommended when labour time is the key toe because contribution per yy, Mbour hs ict A is more than that of product 5. E } When Bos. oe spe key factor, product xe a contribution per wad oduct B is more : é BS When oe nist oF ey factor, product & is move profitable because its contribution Per unit ts higher than tkat of product A,5.20 Renee der, ANGLE OF INCIDENCE oo - his angle is formed by the intersection of sales line and total cost line at the break-even. | - eee neo Pay (see Fig, 5.1). This angle shows the rate at which profits are bein; saned SRE TR BR paint has been reached. The wider the angle, the greater is the rate of earning profits, en has peer reached. will be to have as large an angle as pos : q inci i ‘cular i i iods when sales are expinas The angle of incidence is of particular importance in boom peri na — Taking in conjunction with margin of safety, therefore, a large angle of incidence with 23 | margin of safety indicates and extremely favourable position. COST INDIFFERENCE POINT } Cost indifference point refers to that level of output where the t or the profit of tig two alternatives are equal) Such a level may be tatculated where two or more alternati Rethod of production or machines are considered and the use of one machine involves higher fixed mz and lower variable cost per unit while the other machine involves lower fixed cost and high variable cost per unit. The calculation of point of cost indifference helps in a cost minimisstie exercise and identifies the alternative which is more profitable for a given level of output or sales. A machine with a lower fixed cost and a higher variable cost per unit is more profitate when actual sales are below the point of cost indifference and vice versa, a machine with a hisker fixed cost and a lower variable cost per unit is more profitable when actual sales are ‘more thar the point of cost indifference. The formula for calculation is as follows : aa: ae Difference in fixed cost Cost indifference point (in units) = Difference in contibution per unit aa a Difference in fixed cost Gost indifference point (in ®) = TisterenceinP /Viade Mustration 5.13 GMR Co. Ltd. has to choose between machine X, and X, and provides the following data: i xX, Er. Output per annum (units) 10,000 10,000 Profit at the above level & 30,000 26,000 Fixed cost per annum @ 30,000 16,000 Compute : ; (i) BE, Point of the two machines, (if) Level of output where the two machines are equally profit 7) ’ itabl (iti) The machine suitable for different levels of pe the prvdict Solution Contribution » Fixed cost + Profit | Machine A ~ 30,000 + 30,000 = & 60, 0 | ; = Machine B = 16,000 + 24,000 = & <0.008 C of contribution per unit ~ A = & 60,000 + 10,000 units ~ ay ~ B = % 40,000 + 10,000 units @ Byeak-even point » FC + ¢ ees Aw ® 30,000 + 8 6» 5,000 uni B= ® 16,000 + hone © 4 = 4.000 units 4yo ne Profit Analysis (Break-even Analysis) | 5.28 ost indifference point = ference in Fe ‘a Difference in C 2 30,000 - 16,000 14,000 Seapse rg 7,000 units ‘at 7,000 units, both the machines will produce the same amount of profit. pro! .y yachine B will be more profitable between break-« i i ci Han 400 uns and 7,000 ee eae even point and point of cost indifference jis more profitable when sales one more than 7,000 units. GRAPHIC PRESENTATION OF BREAK-EVEN ANALYSIS preak-even: Chart “even chart is a graphic presentation of break-even is. Thi 7 “om that the point at which the total cost line and tae reside reson point, A break-even chart not only shows the break-even point but also shows profit and loss zt various levels of activity. 280 260 240 220 200 180 Angle of incidence 160 140 Break even point 120 100 Cost and Revenue in & 000 80) 60 40) 20) Margin of safely; Fixed cost ‘Actual sales Break even sales! Te 18 20 22 24 26 28 yo 12 14 24 6 6 ‘alos in ‘000 Units of Production oF Fig, 5:4, BreakeeveR Chast a ; j * bieak-even chart portrays the following information + (i) Mesbeven point ~ the poi at opie ether prot ma ess 1 wade a i output. ihe lng ie nt a(7) The sneegin of salary, : (0) The angie of ieeitence, indicating the rate at which profit is being made. (i) The anouat of co ution at various levels of sales. (This can be shown only on a soe Gesigned ‘contention break-even chart!) Pet Construction of Breck-eves Chart The principal weps in the construction of a break-even chart are as follows : 1. Select 2 scale om Karis. The Lazis is 2 horizontal base line which is drawn and Spaces into equal distences to represent any one or more of the following factors: } Tolume of oxtpret (ox sales (i ropes value) () Peobuction copactty (in percentage) 2 Select scale on Yaris. The Y-azis is 2 vertical line at t 4 spaced into equal Cistexces. Ge this Y-axis, it is usual to 2, Draw the fixed cont tine. This is draomn on Taxis. For exemple, he extreme left of the chart hick show cost and sales in Tupee value parallel to Y-azis, starting from an appropriate pose Sxed cost is ® 30,000, it will be plotted as is shown sa Fig. 5.2 § 8 t Qe aANt Balas ON & + 8 4, Dea fe Std ct Une, The vata cont depicted Poa ere in the wt a 00 Oe Sage (it Nat Tas w tah cone Uine is dian stating fiom the nae nthe Fans Bet sooo) sina corti dram fom C30 “aable cost is ® 50,000 (Fixed cost eis | Ca Yeh 0 at 6 Sik Ok the Yes. THe apes (98 hee ee 5; Draw the eles Une, This Une starts from the 6 Point at the left (ihe a ion ofJ salon Fase ost oh —p—p— pp ey pan ono r & 2 10 ' Fig. $3, Bakoven Chast Steps 4 (Sac Fecs. where there is no production at 2 nil cost) end extends to the point of maxim fay othe sles velne. Further assuming seles T 1,00,000 (Fined cost € 30,000. vecisble cost [Bittg), the seles Hime will be drawn from 0 peint et the left to the T 1,00,000 point on the Se Tats Tks is Mustreted in Fig. 5.4. Bese: ine intersects the total cost line at break-even point representing T 60,000 scles end aa5 en Example The following data is supplied # 40,000 Fixed cost £0,000 eal Oe 1 oe a z 1,40,000 Sales/production 1,40,000 units Draw a break-even chart. Sotution the break-even point in Fig. 5.5 break-even chart is at % 70,000 and 70,000 units his is verified by the following calculations : Fixed cost “ int SCE SO x Sales Break-even point Contribution Contribution sot ! = 60,000 = & 80,000 . 40,000 Break-even point = seggg * 140,000 = © 70,000. Cost and Sales (2) Variable cost Volume of (units) pls Fig, 5,5, Break-even Chait ‘This is an alternate fo: Se at ine 140 Of break-e put. In spch eh ven chart a ‘i he vaca sot ine The chars vaiable cox shows the amount of consti ee is pow shown in Fig, eee ake {daw fist and fixed cost supe With the figuies of ata’ and sales line represent above example, :Break even point Contribution 8 3 § 2 & 5 Loss area : Variable cost 8 Volume of sales (units) Fig. 5.6. Contribution Break-even Chart EFFECT OF CHANGE IN THE PROFIT FACTORS peat een chart can also show the effect of change in any of the fo Change in fixed cost Stange in variable cost (ae in selling price in sales volume. _2ft ofa business can be increased when there is (a) decrease in fixed cost, and/or (b) ee cost, and/or (c) increase in selling price, and (d) increase in sales volume. Gaseean (a), (b) and (¢) factors will have the effect of lowering the break-even point lations + piofit. The separate effect of each of these is shown in the following charts owing factors, which a 51g Fiaeg lig . % 5,000 Variable cost 10 per unit a sales volume 1,000. units # ake % 20 per unit : snettt-even chart and show the effect of the following ° B10 inc 1 Fixed cost (b) 10% decease in variable cost 896 in gelling price __(@), 10% increase in sales volume00 £5,000 _ ¢ 10,000 Fixed cost . % 5,000 Break-even point ~ p/Vratio Ye 0° = 20,000 ~ 5 10,00 Profits = S-F-¥ 000 Uses of Break-even Analysis Some of the important uses of break-even a . It help in determining the break-even Pt ae dei pull help in determining the ¢ ing price which wil ining the selling price wt : it help in determinuns les voll e de P pera It help in determining the sales volume to eam a desired rofit mt eo determining the costs and revenue at different levels of output. it help in determining the most profitable sales aa eras It help in determining comparative profitability of €2° oF st ee It studies the effect of change in sellsa price or of price different marta, and foreign market. est thei a of ee or decrease in fixed and variable costs on profits. It studies the effect on profits and break-even points of high proportion of variable cos; with low fixed cost and vice-versa. 40. It compares the profitability of various firms. 11. It helps in management decision-making, e.g., in make or product line, acceptance of special job, etc. 42. It help in determining cash requirements at different levels of operation with the help of cat break-even charts. Limitations of Break-even Analysis Aithough break-even analysis is an invaluable tool of management, there are some limitations fon which this technique suffers. These limitations of break-even analysis arise from cesta essumptions on which the analysis is based and which are in effect, not true. Thus “breakoe onolysis is based on a simplified model of a business which is unrealistic.” It “must be applet with on intelligent diserimination, with an adequate grasp of assumptions underlying the techie serrouading is practical applications.” The assumptions of break-even analysis have already b= — now it is intended to study the unrealistic nature of these assumptions. 1. The swage tat ll cost can be clearly separated into fixed and variable compone=s sata - jeve accurately in practice, thereby resulting in inaccurate break? | . Th ii z i ie sumption t fae vaste cost per unit remains constant and that it gives 2 stright rea eae ae In practice, many of the variable costs do not ob fe ee ee e ble costs, no doubt, move.in sympathy with the voluse Similarly, the rcessarily in direct proportion to the volume. i Sasa he acumpion that fed cost remains constant is als waves Fixed co when abditional ea range of output and tend to increase by a sudden i? sth erage sod machinery is introduced. / true. Ip roctice, welling eee femaining unchanged as volume changes # ae pives do ot vemain feed and change in prices affects 2 | analysis are summarised below : 2 buy decisions, discontinuance cfme-Profit Analysis (Break-even Analysis) oo SS sat a. iene 14,0004 Cost lino 12,000-) BE, Point i 10,000-4 : 8,000 B.E. Point | Fixod cost tino Cost and revenue () 5,000___ 10,000 15,000 _20,000 Production (units) Fig, 5.13. Break-even chart with more than one break-even point showing that cost and sales lines in actual practice cannot be represented by straight lines. ‘Any increase in output can be sold only by effecting a reduction in selling price which would effect the sales line. assumption that only one product is being produced or that product mix will remain unchanged is also not found in practice. The sales of various products manufactured is not “always in predetermined proportion. Jt is assumed that production and sales are synchronised. This is not always so. Sales may all short of production or may be capable of increase to match production only by effecting © reduction in selling prices. The break-even analysis completely ignores the consideration of capital employed whick may be an important factor in the study of profit analysis. Spite of these limitations, break-even analysis is a very useful management device. It should ei by keeping in mind its limitations because then alone the technique can be used more fively. SUMMARY OF FORMULAE AND ABBREVIATIONS E Contribution (c) = Sales - Variable cost (S~ V) (C) = Fixed cost + Profit (r+) (C) = Fixed cost ~ Loss (F-L) gin S-V = FeP in SUN tela P/V ratio Also Contribution = Sales in & « i : Contibution = (Sales at BEP in & x P/V sai) ¢ Pr pea Contribution + (Sales at BEP in units Contribution we i a Contribution (Margin of Safety in © » P/V ratio) + fre cot Contsibution = (Qfargin of Safety in units » € per uit) Profit Contsibution = Ffgjgin of safety ine