Lesson 5- Part 1BREAKEVEN ANALYSIS / COST VOULME PROFIT ANALYSIS

Learning Objectives

1. Cost Classification

2. BEP Calculations (in Units / in Value)

3. BEP Interpretations

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DEFINITION

• Breakeven analysis is the business analysis performed to determine the probable point when your business will be able to cover all its expenses and begin to make a profit

• Breakeven analysis can be done to determine either the breakeven point or the breakeven volume.

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BREAKEVEN POINT -Interpretations

It is the point in your business transactions when business does not have either profit is loss of doing that business. (P=L=0)

It is the point that above it, the business starts making profit (revenue exceeds costs), all factors remaining constant. At the breakeven point: TOTAL REVENUE = TOTAL COST

This is the point in which to recover the fixed cost of the business.

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PERSPECTIVES

• Breakeven point can be determined in terms of:

• Time - how long will you be in business to be able to start making profit?

• Units of sales – how many units of your product will you will be able to sell before making profit? Break Even in units

• Sales revenue – how much revenue do you need to generate to start making profit? Break Even in Value

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IMPORTANCE OF BEP ANALYSIS

1. It helps to identify your start-up costs

2. It also helps to determine the sales revenue needed to pay for ongoing business expenses.

3. Breakeven point analysis helps the business to determine its gross (or contribution) margin

4. Breakeven point analysis aids in developing proper product pricing strategy through knowledge of its gross margin.

5. The breakeven point is an important reference point that enters into planning and carrying out business activities.

6. A clear understanding of the sales volume needed to cover all costs (mentioned in point 2 above) helps the business to know:

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CALCULATION OF BREAKEVEN POINT

• REMEMBER:

AT BREAKEVEN POINT:

PROFIT = 0

LOSS = 0

PROFIT = LOSS

Revenues of the business are equal to its total costs and its contribution margin equals its total fixed costs. 6

Important Calculation for BEP Analysis• Fixed Cost/Fixed Overhead

• Variable Cost

• Total cost = Fixed Cost + Variable Cost

• Contribution Margin Per unit = Selling price per unit – Variable cost per unit

• Total Contribution = Contribution Margin Per unit x Number of units

• Total Sales Value = Selling Price per unit x No. of units

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CALCULATION OF BREAKEVEN POINT

To calculate the breakeven point,

• You will need to identify your fixed and variable costs.

BASIC FORMULA:

• Breakeven point(in Units) = fixed costs/ Contribution Margin per unit

• Contribution margin per unit= (unit selling price – variable costs).

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EXAMPLE

XYZ Corporation has calculated that it has fixed costs that consist of its lease, depreciation of its assets, executive salaries, and property taxes. Those fixed costs add up to $60,000. Their product is the widget. Their variable costs associated with producing the widget are raw material, factory labor, and sales commissions. Variable costs have been calculated to be $0.80 per unit. The widget is priced at $2.00 each.

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Given this information, we can calculate the breakeven point for XYZ Corporation's product, the widget, using our formula above:

$60,000 ÷ ($2.00 - $0.80) = 50,000 units

What this answer means is that XYZ Corporation has to produce and sell 50,000 widgets in order to cover their total expenses, fixed and variable. At this level of sales, they will make no profit but will just break even.

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CALCULATION-BEP in Sales Value

• Break-even point in number of sales dollars is calculated using the following formula:

Break-even Sales Dollars = Price per Unit ×Break-even Sales Units

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CALCULATION-BEP in Sales Value

EXAMPLE 1

Calculate break-even point in sales units and sales dollars from following information:

Price per Unit = $15

Variable Cost per Unit = $7

Total Fixed Cost = $9,00012

CALCULATIONWe have,p = $15v = $7, andFC = $9,000

Substituting the known values into the formula for breakeven point in sales units, we get:

Breakeven Point in Sales Units (x):= 9,000 ÷ (15 − 7)= 9,000 ÷ 8= 1,125 units

Break-even Point in Sales Dollars = $15 × 1,125 = $16,875

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Contribution Approach Formulas

• BEP in Sales Units

We learned that, at break-even point, the CVP analysis equation is reduced to:

px = vx + FC

Where p is the price per unit, x is the number of units,

v is variable cost per unit, and

FC is total fixed cost.

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Contribution Approach Formulas

Solving the above equation for x (i.e. Break-even sales units):

Break-even Sales Units = x = FC ÷ ( p − v )

Since unit contribution margin (Unit CM) is equal to unit SALE PRICE (p) less unit variable cost (v), So,

Unit CM = p − v

Therefore,

Break-even Sales Units = x = FC ÷ Unit CM

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Contribution Approach Formulas

• BEP in Sales Dollars

Break-even point in dollars can be calculated via:

Break-even Sales Dollars = Price per Unit ×Break-even Sales Units ;

or

Break-even Sales Dollars = FC ÷ CM Ratio

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Contribution Approach Formulas

EXAMPLE-2

• Calculate the break-even point in units and in sales dollars when SALES PRICE per unit is $35, variable cost per unit is $28 and total fixed cost is $7,000.

• SolutionContribution Margin per Unit = ( $35 − $28 ) = $7Break-even Point in Units = $7,000 ÷ $7 = 1,000Break-even Point in Sales Dollars = 1,000 × $35 or $7,000 ÷ 20% = $35,000

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EXAMPLE-3

• A company has a product, which is sold @ $21 per unit. The per unit variable costs are $14. Fixed costs are $0.70 per unit at the budgeted production level of 300000 units.

Required:

• What is the break even level in units and sales revenue?

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Example-4

• A manufacturer produces 1500 units of products annually. The marginal cost of each product is Rs. 960 and the product is sold for Rs. 1200. Fixed cost incurred by the company is Rs. 48, 000 annually. Calculate P/V Ratio and what would be the break ‐ even point in terms of output and in terms of sales value?

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• A. Contribution per unit = Sales – Variable cost = Rs. 1200 –Rs. 960 = Rs. 240

• B. P/V Ratio = Contribution / Sales x 100 = 240/1200 x 100 = 20%

• C. Break‐even point (in units) = Fixed cost / Contribution per unit =

• D. Break‐even point (in Rs.)

=48, 000 /240 = 200 units

= Break‐even point x selling price per unit

= 200 x 1200 = 2, 40, 000OR

= Fixed cost / P/V Ratio48, 000 / 20% = 2, 40, 000

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