Farm Power & Machinery Management 3(2+1)

Lesson 20. Break-even point

px = vx + FC + Profit

where,

p is the price per unit

x is the number of units

v is the variable cost per unit, and

FC is total fixed cost

It can be also expressed as

[Break even sales = fixed cost + variable cost]

The break-even point can be calculated using either the equation method or contribution margin method. These two methods are equivalent.

At break-even point the profit is zero, therefore the cost volume profit (CVP) formula is simplified to

px = vx + FC

Solving the above equation for x which equals break-even point in sales unit, we get:

                                                  FC

Break-even Sales Units =     x   ----------     

                                                 p - v

Equation Method : The equation method centres on the contribution approach to the income statement. The format of this statement can be expressed in equation form as follows:

Profit = (Sales − Variable expenses) − Fixed expenses

Rearranging this equation slightly yields the following equation, which is widely used in cost volume profit (CVP) analysis:

Sales = Variable expenses + Fixed expenses + Profit

For example we can use the following data to calculate break-even point.

• Sales price per unit = Rs. 250

• variable cost per unit = Rs.150

• Total fixed expenses = Rs. 35,000

Calculate break-even point 

Calculation:

Sales = Variable expenses + Fixed expenses + Profit

250Q* = 150Q* + 35,000 + 0**

100Q = 35000

Q = 35,000 /100

Q = 350 Units

Q* = Number (Quantity) of units sold.

**The break-even point can be computed by finding that point where profit is zero

The break-even point in sales can be computed by multiplying the break-even level of unit sales by the selling price per unit.

350 Units × 250 Per unit = Rs. 87,500

Benefits / Advantages of Break Even Analysis : The main advantages of break-even point analysis are that it explains the relationship between cost, production, volume and returns. It can be extended to show how changes in fixed cost, variable cost, commodity prices, and revenues will affect profit levels and break-even points. Break-even analysis is most useful when used with partial budgeting, capital budgeting techniques. The major benefits to use break-even analysis are that it indicates the lowest amount of business activity necessary to prevent losses.

Assumption of Break Even Point : The Break-even Analysis depends on three key assumptions :

(i) Average per unit sales price (per-unit revenue): This is the price that you receive per unit of sales. Take into account sales discounts and special offers. Get this number from your Sales Forecast. For non-unit based businesses, make the per-unit revenue  and enter your costs as a percent of a Rupees. The most common questions about this input relate to averaging many different products into a single estimate. The analysis requires a single number, and if you build your Sales Forecast first, then you will have this number. You are not alone in this, the vast majority of businesses sell more than one item, and have to average for their Break-even Analysis.

(ii) Average per-unit cost: This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per Rupees of revenue or unit of service delivered, to deliver that service. If you are using a Units-Based Sales Forecast table (for manufacturing and mixed business types), you can project unit costs from the Sales Forecast table. If you are using the basic Sales Forecast table for retail, service and distribution businesses, use a percentage estimate, e.g., a retail store running a 50% margin would have a per-unit cost of .5, and per-unit revenue of 1.

(iii) Monthly fixed costs: Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. Instead, we recommend that you use your regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses). This will give you a better insight on financial realities. If averaging and estimating is difficult, use your Profit and Loss table to calculate a working fixed cost estimate—it will be a rough estimate, but it will provide a useful input for a conservative Break-even Analysis.

Limitations of Break Even Analysis : It is best suited to the analysis of one product at a time. It may be difficult to classify a cost as all variable or all fixed; and there may be a tendency to continue to use a break even analysis after the cost and income functions have changed.