Break Even Point
- Pages: 3
- Word count: 654
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Break-even point is that point at which there is neither profit nor loss. It is at point costs are equal to sales. It is otherwise called as balancing point, neutral point, equilibrium point, loss ending point, profit beginning point etc. After BEP is achieved, all the further sales will contribute to profit.
At BEP, Sales – Variable cost = Fixed costs. OR Contribution = Fixed costs.
Break-even analysis is an analytical technique that is used to determine the probable profit at any level of production. It is basically an extension of marginal costing.
Advantages of Break-even analysis
1. Profit planning
2. Product planning
3. Activity Planning
4. Lease Decisions
5. Make or buy decisions
6. Capital profit decisions
7. Distribution channel decisions
8. Price decisions
9. Choosing Promotion Mix
10. Decision regarding profitability of products or department. Some basic assumptions of break even analysis are:-
1. All costs are classified into fixed and variable costs.
2. The sales mix always remains constant.
3. There is no change in the general price level.
4. The sole influencing variable on costs and revenues is the volume,
5. The revenue and costs are linear.
6. Company’s stocks are valued at the marginal cost.
7. The units produced and the units sold are the same.
The break even point-the point, at which an organization’s revenues and expenses are equal, is termed as the break even point. For example, when at a particular amount of sales, the organization incurs no profit or loss, it normally breaks even.
Applications of break even analysis:-
The break even point is considered to be one of the simplest methods which are used for analytical tools in management. The break even analysis gives a dynamic view of the relationship between cost, profit and sales. By studying the beak even sales graph, the managers can know when to expect a break even. The use of break even point for target income sales is a very important tool in financial analysis. Plant shutdown decisions:
The management under certain circumstances might feel that shut down , that is, closing down the business is better than operating at a loss. However , marginal costing analysis may prove that this is not always so. This type of situation usually arises when sufficient sales cannot be achived. Types:
1. Temporary suspension of production activities:
It’s a short term measure.
The objective is usually to stop operations until trade depression has passed. The question before management is : When should operation be suspended? Or in other words how long the operations be continued? The answer is :
If products are making contribution towards fixed cost, then production should not be suspended. Because continuing production will help minimizing loss which would be incurred if plant is shut down. Thus, the infoemation needed to solve this type of problem involves comparision between probable loss at a given level of output and the loss that would be suffered if production is suspended temporarly. Example: A manufacturing co supplies following information:
Normal capacity of plant: 10000 units
Fixed cost : rs 100000
Marginal cost per unit: Rs 75
Estimated selling price: RS 80
Estimated sales volume at this SP: 5000 units
Marginal cost Statement—-
Total sales (5000 units X rs 75) = 400000
Less: MC ( 5000 units X rs 75) = 375000
Contribution : rs 25000
Fixed cost: 100000
Loss : 75000
If the plant is shut down, the loss due to FC would be rs 100000. However if plat is operated loss will be only rs 75000.
2. Permanent closing down of production- such a decidion is a drastic step and should be taken when in the long run, the business does not expect to earn a sufficient return to cover the risk involved. In other words, in the long run, selling price must only cover the total cost but should also give a reasonable return on the capital employed.