Break Even Analysis is a costing technique that help executives in profit planning. The BEP is defined as the volume of activity at which total sales revenue exactly equal total cost of the output produced or sold. Since at this level of operation sales revenue is adequate to cover all the cost to manufacture and sell the product leaving no amount as profit and , therefore, this level is known as no profit and loss level.
Assumptions of Break Even Analysis
The break even analysis is based on the following assumptions-
- All the cost can be segregated into fixed and variable cost.
- Fixed cost remain constant at all level of output.
- Selling price will remain unchanged.
- Sales mix will remain constant.
- Stocks are valued at marginal cost.
- Variable cost vary in direct proportion to the volume of output.
Method of Break Even Analysis
There are two method of break even Analysis-
- Mathematical method
- Graphical method
Mathematical Method
This method is based on the following concepts-
- Contribution
- Profit Volume
- Break Even Point
- Margin of Safety
Contribution
Contribution is the excess of sales over variable cost which is known as total margin or contribution. It is found out as follows -
Sales- Variable cost=Contribution or
Contribution =Fixed cost + Profit
Profit Volume Ratio PV Ratio (P/V Ratio)
P/V Ratio, mainly known as the contribution to sales ratio. it ratio exhibit the relationship of contribution to sales. It is computed as follows -
P/V Ratio=Contribution/Sales ×100 or
P/V Ratio=Sales-variable cost/sales×100
Break Even Point
Break Even Point is the point of no profit no loss. it is the point at which sales revenue equal total cost. sales beyond break even point indicates profit and below this point, Sales indicate loss. It is computed as follows -
BEP (in units) = FC/contribution per unit
BEP (in Rs) =FC/Sales - VC ×Sales
Margin of Safety
Margin of Safety is the difference between actual sales output and Break even sales. It may also be expressed as percentage. it can be calculated as follows-
MOS = Total Sales - Break Even Sales or
MOS = Profit/P/V Ratio
