BREAKEVEN ANALYSIS – CHARTS AND GRAPHS

The conventional break-even chart

The conventional break-even chart plots total costs and total revenues at

different output levels and shows the activity level at which break-even is

achieved. Conventional break-even chart

The chart or graph is constructed as follows:

• Plot fixed costs, as a straight line parallel to the horizontal axis

• Plot sales revenue and variable costs from the origin

• Total costs represent fixed plus variable costs.

The point at which the sales revenue and total cost lines intersect indicates

the breakeven level of

output. The amount of profit or loss at any given output can be read off the

chart. By multiplying the sales volume by the unit price at the break-even

point the level of revenue needed to break even can be determined. The

chart is normally drawn up to the budgeted sales volume. The difference

between the budgeted sales volume and break-even sales volume is referred

to as the margin of safety.

Usefulness of charts

The conventional form of break-even charts was described above. Many

variations of such charts

exist to illustrate the main relationships of costs, volume and profit.

Unclear or complex charts should, however, be avoided, as a chart which is

not easily understood

defeats its own object.

Generally, break-even charts are most useful for the following purposes:

• comparing products, time periods or actual outcomes versus planned

outcomes

• showing the effect of changes in circumstances or to plans

• giving a broad picture of events,

Cost & Management Accounting (MGT-402) VU

(C) Copyright Virtual University of Pakistan 196

Contribution break-even charts

A contribution break-even chart is constructed with the variable costs at the

foot of the diagram

and the fixed costs shown above the variable cost line.

The total cost line will be in the same position as in the break-even chart

illustrated above; but by

using the revised layout it is possible to read off the figures of contribution at

various volume

levels, as shown in the following diagram.

Break-even point - Break-even point is the point of sale at which company makes neither profit nor loss.

The marginal costing technique is based on the idea that difference of sales and variable cost of sales

provides for a fund, which is referred to as contribution. Contribution provides for fixed cost and profit.

At break-even point, the contribution is just enough to provide for fixed cost. If actual sales level is above

break-even point, the company will make profit. If actual sales are below break-even point the company

will incur loss. When cost -volume-profit relationship is presented graphically, the point, at which total

cost line and total sales line intersect each other, will be the break-even point.

Computation of Break-even Point

 Fixes Cost

B.E.P.(in Value or sales) = (i) -------------------------- x Sellingprice perunit

Contribution per Unit

Fixes Cost

(ii) ------------------------- x Total Sales

Total Contribution

Fixes Cost

(iii) --------------------------

Variable cost per unit

1- ------------------------

Selling price per unit

Fixed Cost

(iv) --------------

P\V Ratio

Note : If the volume of output of sales is to be computed for a desired profit, the amount of desired

profit is to be added to fixed cost in the above formulae.

Profit/Volume Ratio, When the contribution from sales is expressed as a percentage of sales value, it is

known as profit/volume ratio (or P/V ratio) it expresses relationship between contribution and sales.

Better P/V ratio is an index of sound financial health of a company's product. This ratio reflects change in

profit due to change in volume. Broadly speaking, it shows how large the contribution will appear, if it is

expressed on equal footing with sales. The statement that P/V ratio is 40% means that contribution is
Rs.40, if size of the sale is Rs.100.One important characteristic of P/V ratio is that it remains the same at

all levels of output, P/V ratio is particularly useful, when it is considered in conjunction with margin of

safety. The other terms being used to refer to P/V ratio are: (a) marginal income ratio, (b) contribution to

sales ratio, and (c) variable profit ratio.

P/V ratio may be expressed as:

P/V ratio = (Sales- Marginal cost of sales) Sales

or = Contribution/Sales

or = Change in contribution/Change in sales

or = Change in profit/Change in sales

P/V ratio remains constant at different levels of operations. A change in fixed cost does not result in

change in P/V ratio since P/V ratio expresses relationship between contribution and sales.

Advantages of P/V Ratio

(i) It helps in determining the break-even point.

(ii) It helps in determining profit at various sales levels.

(iii) It helps to find out the sales volume to earn a desired quantum of profit.

(iv) It helps to determine relative profitability of different products, processes and departments.

Limitations of P/V Ratio.

1. P/V ratio heavily leans on excess of revenues over variable cost.

2. The p/V ratio fails to take into consideration the capital outlays required by the additional

productive capacity and the additional fixed costs that are added.

3. Inspection of P/V ratio of products can suggest profitable product lines that might be emphasized

and unprofitable lines that may be re-evaluated or eliminated. Mere inspection of P/V ratio will

not help to take final decision. For this purpose, analysis has to be broadened to take into

consideration differential cost of the decision and opportunity costs, etc. Thus, it indicates only

the area to be probed.

4. The P/V ratios has been referred to as the questionable device for decision-making because it

only gives an indication of the relative profitability of the products/product lines that too if other

things are equal P/V ratio is good for forming impression and not for making decision.

The above points highlight that P/V ratio should not be used inconsiderately. Its limitations should be

alive in the mind of user.

Effects on Break-even Point and P\V Ratio

B.E.Point P\V Ratio

(i) Increase in Fixed Costs Increase No effect

(ii) Increase in Sale No effect No effect

(In Units) (only total profits increase)

(iii) Decrease in Variable Reduction Increase

Cost per Unit ( S.P.being the same)

(iv) Reduction in Sales Increase Reduction

Price ( i.e. S.P.)