Breakeven Analysis

Part I : Background
1.1 Definition of Breakeven Analysis
Breakeven analysis is also known as cost-volume-profit analysis.
It is the study of the relationship between selling prices, sales volumes, fixed costs,
variable costs and profits at various levels of activity.
1.2 Application of breakeven analysis
Breakeven analysis can be used to determine a companys breakeven point (BEP).
Breakeven point is a level of activity at which the total revenue is equal to the total costs.
At this level, the company makes no profit. With reference to the breakeven point, the
managers can set their sales goals and target profits.
1.3 Assumption of breakeven analysis
The model of breakeven analysis is developed on the following assumptions:
Relevance rangeIt is assumed that a company is operating within a relevant range.
The relevant range is the range of an activity over which the fixed cost will remain
fixed in total and the variable cost per unit will remain constant.
Fixed costsTotal fixed costs are assumed to be constant in total. Fixed costs per
unit will decrease with the increasing number of units produced.
Variable costsVariable costs per unit are assumed to be constant. Total variable
costs will increase with the increasing number of units produced.
Sales revenue ---Sales revenue per unit is assumed to be constant and the total
revenue will increase with the increasing number of units produced.
These assumptions are illustrated in the following diagrams:
Costs ($)

Total Costs
Variable costs

Fixed costs

Sales (Units)
Total cost/ Revenue ($)

Sales Revenue
Profit
Total costs

Sales (units)
BEP
Part II : Breakeven Analysis
2.1 Breakeven point
Breakeven point is the level of activity at which the company makes neither profit nor loss.
It is also the activity level at which the total contribution is equal to the total fixed costs.
Contribution is defined as the excess of sales revenue over the variable costs.

 The following diagram illustrates the definition of contribution.

Profit
Sales
revenue

Contribution

Fixed costs

Variable costs

Formulas for breakeven analysis.

Breakeven point in units = Fixed costs / Contribution per unit

Breakeven point in units =

Contribution required to break even

Contribution per unit

Sales revenue at breakeven point =

Contribution required to break even X Selling price
Contribution per unit

Sales revenue at breakeven point =

Contribution required to break even
Contribution to sales ratio
2.2 Example 1
Selling price per unit-- $12
Variable cost per unit -- $3
Fixed costs-- $45,000
You are required to compute the breakeven point.
Breakeven point in units
= Fixed costs / Contribution per unit
=
Sales revenue at breakeven point =
Alternative method
Contribution to sales ratio =
Sales revenue at breakeven point =

Contribution required to break even

Contribution to sales ratio

=
Breakeven point units =
2.3 Target Profit
No. of units at target profit =

Fixed

costs
+
Target
Contribution per unit

Profit

2.3.1 Example 2
Selling price per unit --$12
Variable cost per unit -- $3
Fixed costs-- $45,000
Target profit-- $18,000
You are required to compute the sales volume required to achieve the target profit.
No. of units at target profit =

Fixed

costs
+
Target
Contribution per unit

Profit

Required sales revenue =

Alternative method
Required sales revenue = Fixed costs+target profit/Contribution to sales ratio
=
Units sold at target profit =
2.4 Margin of safety
Margin of safety is a measure of amount by which the sales may decrease before a
company suffers a loss. This can be expressed as a number of units or a percentage of
sales.
2.4.1 Example 3
The breakeven sales level is at 5,000 units. The company sets the target profit at $18,000
and the budgeted sales level at 7,000 units.
You are required to calculate the margin of safety in units and express it as a
percentage of the budgeted sales revenue.
Margin of safety = Budgeted sales level breakeven sales level
=
Margin of safety =
The margin of safety indicates that the actual sales can ______________units or
__________ from the budgeted level before losses are incurred.
2.5 Changes in components of breakeven analysis
The following example demonstrates the effects of the changes in different components of
breakeven analysis.
2.5.1 Example 4
Selling price per unit --$12
Variable cost per unit --$3
Fixed costs-- $45,000
Current profit-- $18,000
If the change in selling price is raised from $12 to $13, the minimum volume of sales
required to maintain the current profit will be:
(Fixed costs + Current profit) / Contribution per unit
=
If the fixed costs fall by $5,000 but the variable costs rise to $4 per unit, the minimum
volume of sales required to maintain the current profit will be:

(Fixed cost + Current profit)/ Contribution per unit

=
2.6 Limitations of breakeven analysis
Breakeven analysis assumes that fixed costs, variable costs and sales revenue behave in a
linear manner. However, some overhead costs may be stepped in nature rather than remain
constant. The previously straight sales revenue line and total cost line tend to curve
beyond a certain level of production. As a result, a lower selling price is set to stimulate
further sales and lower variable costs can be obtained due to mass production.
It is assumed that all production is sold. The breakeven chart does not take the changes in
stock level into account.
Breakeven analysis can provide vital information for small and relatively simple companies
that produce large volume of the same product. It is not so useful for the companies
producing multiple products. Its applications tend to be limited especially in those jobbing
companies where each item produced is different.
SOLUTION: 7(Nov-2011-foreign ex)
Given,
$ 1 = Tk. 73.9020 - 74.8030
1 = $ 1.6150 - 1.6180
So, 1 = Tk. 73.90201.6150 - 74.80301.6180 = Tk. 119.3517 - 121.0313
Exchange Margin = Tk. 0.20
SWIFT Charges (1/32 %) = 121.0313 1/32 % = 0.0378
Required Rate, 1 = Tk. 121.0313 + 0.20 + 0.0378 = Tk. 121.2691
The required amount to be realized = 121.2691 1,000 = Tk. 1,21,269.10
SOLUTION: 8(Nov-2011)
Given,
$ 1 = Tk. 73.9020 - 74.8030
1 = $ 1.4947 - 1.4957
So, 1 = Tk. 73.90201.4947 - 74.80301.4957 = Tk. 110.4613 - 111.8828
Interest Charges (10%) = 110.4613.10(130/360) = 3.9889
Profit Margin = 0.1000
Usance Rate, 1 = 110.4613 - 3.9889 - 0.1000 = Tk. 106.3724