Learning Objectives:
After studying this, you should be able to:
· explain the concept of break even analysis.
· state the assumptions behind break even
analysis.
· explain the meaning and importance of C-V-P
analysis.
· use C-V-P analysis for short run planning and
decision-making.
9.1
Break-Even
Analysis
9.1.1 The Concept of Break-Even Analysis
Break even is a
situation of neither profit nor loss; it is about a win-win or loss- loss
position as two competing things or persons are put together to realize a
result. In Accounting, especially Management Accounting, break even is normally
studied taken the point of intersection between cost and revenue into
consideration. That point of intersection is called breakeven point and it
shows a situation of neither profit nor loss.
The study of
Cost-Volume-Profit relationship is frequently referred to as 'break-even
analysis', but break even analysis is only incidental to the study of the
relationship between cost, sales, profit/loss and sound management. Up to the
point of activity where total revenues equal total expenses, the study can be
termed as 'break-even analysis', while, beyond this point, it is the
application of Cost-Volume-Profit relationship.
Thus, the term
'break-even analysis' may be interpreted in two senses - narrow sense and broad
sense. In its narrow sense, it refers to a system of determining that level of
operations where total revenues equal total expenses, i.e. the point of zero
profit. Taken in its broad sense, it denotes a system of analysis that can be
used to determine the probable profit at any level of operations.
necessary
corrections is in progress.
Thanks.
9.1.2 Assumptions of Break-even Analysis
Break even
analysis and Cost-Volume-Profit analysis are based upon certain assumed
conditions which are to be rarely found in practice. Some of these basic
assumptions are as follows:
i.
The principle of
cost variability is valid.
ii. Costs can be resolved into their fixed and
variable components.
iii. Fixed costs remain constant.
iv. Variable costs vary proportionally with
volume.
v.
Selling price
does not change as volume changes.
vi. There is only one product or, in the case of
multiple products, sale mix remains constant.
vii. There will be no change in general price
level.
viii. Productivity per worker remains mostly
unchanged.
ix. There is synchronization between production
and sales.
x.
Revenue and costs
are being compared with a common activity base, e.g. sales value of production
or units produced.
xi. The efficiency of plant can be predicted.
A change in any
one of the above factors will alter the break-even point so that profits are
affected by changes in factors other than volume. Thus, the break-even chart
must be interpreted in the light of the limitations of underlying assumptions,
especially with respect to price and sale mix factors.
9.1.3 Presentation of Break-even Analysis
Usually,
'break-even analysis' is presented graphically as this method of visual
presentation is particularly well-suited to the needs of business owing to the
manager being able to appraise the situation at a glance. Thus, it removes the
danger accompanying many accounting reports, a danger that the reader would get
bogged down with unnecessary details in such a way that he may never come to
grips with the heart of the matter. The graphical break-even analysis
eliminates the details and presents the information in a simplified way. To
that extent, it is especially attractive for a person of non-accounting
background. When presented graphically the break-even analysis takes the shape
of 'break-even‟ chart or charts.
295
necessary
corrections is in progress.
Thanks.
A break-even
chart shows the profitability, or otherwise, of an undertaking at various levels
of activity and, as a result, indicates the point at which neither profit is
made nor loss is incurred.
Break-even charts
are frequently used and needed where a business is new or where it is
experiencing trade difficulties. In these cases, the chart assists management
in considering the advantages and disadvantages of marginal sales. However, in
a highly profitable enterprise, there is little need of break-even charts
except when studying the implications of a major expansion scheme involving a
heavy increase in fixed charges.
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