BREAK-EVEN POINT

Break-Even Point is the level of sales required to reach a position of no profit, no loss. At Break-Even Point, the contribution is just sufficient to cover the fixed cost. The organization starts earning a profit when the sales cross the Break-Even Point. Break-Even Point can be calculated either in terms of units or in terms of cash or in terms of capacity utilization. It can be calculated as follows:

BEP in units = Fixed Cost / Contribution per unit

BEP in cash = Fixed Cost / P.V. Ratio

BEP in terms of capacity utilization = (BEP in units / Total capacity) x 100

The margin of Safety:

The positive difference between the sales volume and the break-even volume is known as the margin of safety. The larger the difference, the safer the organization is from a loss-making situation. It can be calculated either in cash or in units.

The margin of Safety can be derived as follows:

The margin of Safety = Actual Sales – Break even Sales or,

Margin of Safety (in cash) = Profit / P/V Ratio

Margin of Safety (in units) = Profit / Contribution Per unit

The angle of Incidence:

The angle of incidence is an indicator of profit-earning capacity above the break-even point. A wider angle will indicate higher profitability, while a narrow-angle will indicate very low profitability.

If the margin of safety and angle of incidence are considered together, they will provide significant information to management regarding the profit-earning position of the undertaking. A high margin of safety with a wider angle of incidence will indicate the most favorable condition of the business.

Break-even Chart:

The break-even chart is a graphical representation of the cost-volume-profit relationship. It depicts the following:

a) Profitability of the firm at different levels of output.

b) Break-even point - No profit no loss situation.

c) Angle of Incidence: This is the angle at which the total sales line cuts the total cost line. It is shown as angle ? (theta). If the angle is large, the firm is said to make profits at a high rate and vice versa.

d) Relationship between variable cost, fixed expenses, and contribution.

e) Margin of safety representing the difference between the total sales and the sales at the breakeven point.

Different types of Break-even charts

a) Contribution Breakeven Chart: This chart shows contribution earned by, the firm at different levels of activity.

b) Cash Breakeven Chart: In this chart variable costs are assumed to be payable in cash. Besides this, the fixed expenses are divided into two groups, viz. (a) those expenses which involve cash outflow e.g. rent, insurance, salaries, etc., and (b) those which do not involve cash outflow. e.g., depreciation.

c) Control Breakeven Chart: Both budgeted and actual cost data are depicted in this chart. This chart is useful in comparing the actual performance of the firm with the budgeted performance for exercising control

d) Analytical break-even chart: This chart shows the break-up of variable expenses into important elements of cost. Viz. direct materials, direct labor, variable overheads, etc. Also, the appropriations of profit such as ordinary dividends, preference dividends, reserves, etc. are depicted in this chart.

e) Product-wise break-even chart: Separate break-even charts for different products can also be prepared to compare the profitability of the products or their contribution.

f) Profit graph: A profit graph is a special type of break-even chart, which shows the profits or loss at different levels of output.

Limitations of break-even chart

a) The variable cost line need not necessarily be straight because of the possibility of operation of the law of increasing returns or decreasing returns.

b) Similarly, the selling price will not be a constant factor. Any increase or decrease in output is likely to have all influence on the selling price.

c) When several products are produced separate break-even charts will have to be calculated. This poses a problem of apportionment of fixed expenses to each product.

d) Break-even charts ignore the capital employed in business, which is one of the important guiding factors in the determination of profitability.

ILLUSTRATION 4

Assuming that the cost structure and selling price remain the same in periods A and B find out

Profit volume ratio

Fixed cost

The breakeven point for sales

Profit when sales are $ 1,00,000

Sales required to earn a profit of $20,000

The margin of safety at profit $15,000

Variable cost in period B

PERIOD	SALES	COST	PROFIT
	AMOUNT	AMOUNT	AMOUNT
A	1,20,000	1,11,000	9,000
B	1,40,000	1,27,000	13,000

Answer rating: 100% (QA)

Answer SOLUTION a pv ratio 20 b fixed cost sales pv r... View the full answer