Break Even Analysis

• Lending bank receives request from the

existing borrower to provide additional fund in
term of WC or Term Finance either for
diversification of the product line or to
enhance the existing level of production as the
present condition is not profitable for them.
• Bank need to analysis the feasibility of the
same not to put more fund into the risk prone
existing business . Also if not funded, then
existing operation might face adverse impact
on operation.
• Absorption cost Methodology : All cost
elements are proportionately absorbed in the
process of working out the final selling price of
the product.
• Not much helpful in decission making process.
• The extent and level of profitability may be
ascertained in a better manner by marginal
cost analysis method
Sales Unit 100 tonnes
Sales amount 1000
Raw material consumption 500
Direct Labour 100
Power & Fuel 200
Freight inward 30
Godown rent 60
Salary to godown watchmen 60
Salary to clerical staffs and
supervisors 162
Intrest to bank 34
Miss expenses 20
Total cost 1166
Net loss 166

( Amount in Rs 000s)

• Promoters got a confirmed 350 tonnes order at Rs 9500

per tonne and asking for additional finance.
• The Items of expenditure of a business
enterprises can broadly divided into two
categories.
• Variable expenses : like cost of raw material,
direct labour cost, etc which vary directly in
proportion with the change in the level of
operation.
• Fixed Expenses : Like rent, salary of admin
staffs, etc which may not have any direct prop
with level of operation.
• The interim surplus generated ( Sales –
Variable cost) contributes towards covering the
fixed cost element called contribution and it
increases or decrease with every unit of
product sold or returned. Therefore the
interim surplus is called Marginal contribution .
• The point or level of activity at which the total
contribution fully covers the fixed cost of
operation , is called Break even point and
beyond that level of operation, organization
fetches profit out of the operation.
 Last Yr Amount Proposed for Amount for
  actual per tonne current yr tonne
Sales Unit 100 tonnes   350 tonnes  
         
Sales amount 1000 10 3325 9.5
         
Variable Cost        
Raw material consumption 500 5 1750 5
Direct Labour 100 1 350 1
Power & Fuel 200 2 700 2
Freight inward 30 0.3 105 0.3
Total Variable Cost 830 8.3 2905 8.3
         
Contribution 170 1.7 420 1.2
         
Fixed Cost 336   336  
         
Net Profit / loss 166 loss   84 profit  
 Formulation of an expression
representing break even point
• At break even point , total revenue is equal to
total cost i.e. profit is zero.
• Total cost = variable cost + fixed cost
= (No of unit produced * variable cost per unit
of product ) + Fixed cost
Total revenue = No of unit produced * sales
price per unit product
Break Even Sales = (Fixed expenses / Total
Contribution ) * Total Sales
Break Even Unit = (Fixed Expenses / Total
Contribution ) * Sales Unit

Break Even sales = (336 /420) * 3325 = 2660

Break Even unit = (336 / 420 ) * 350 = 280
 Semi – Variable Cost Elements
• There are few cost elements which neither
vary proportionately with the level of
production nor tend to remain fixed. These
expenses are called semi variable elements
which needs to segregated from fixed and
variable components to ensure purity of
analysis.
   Proposed for current yr Proposed for current yr
Sales Unit 350 tonnes 370 tonnes
Sales amount 3325 3515
Other Variable Cost 2205 2331
Power & Fuel (Semi Variable ) 575 605
Out of which    
Variable component 525 ( 3325 * 0.1578) 555 (3515 * 0.1578)
Fixed component 50 ( 575 - 525 ) 50 (605 - 555 )
Total variable cost 2730 2886
Contribution 595 629
     
Fixed Cost 336 336
Total Fixed Cost 386 386
Break Even Sales 2157 ( 386*3325/595) 2157 (386*3515/629)

• The Power and Fuel has actually shown per unit

expenses of 1.63 per unit sales against the Rs 2 per
unit as per last projection which is semi - variable in nature.
 Method of Segregation
 Compute the semi variable cost during the period. (605 –
575 = 30)
 Compute the corresponding change in sales . ( 3515
– 3325 = 190)
 Variability factor = Change in semi variable cost / change in
sales (30 /190 = 0.1578)
 Multiply the sales figure for the individual year with variable
factor to find the variable portion of the semi variable cost for
the year.
 Subtract the variable cost portion from semi variable cost to
find the fixed cost portion.
 Variable cost component and fixed cost component clubbed
separately and break even position found out as per process.
 Margin of Safety
A manufacturer sets a benchmark for its level of operation
that always include a safety cushion above the B/E level of
operations. This cushion takes care of any downward
movement of the level of operation below the expected
level in a competitive and uncertain environment. This
additional level of sales beyond the BE level of sales called
margin of safety which is expressed in percentage term as

MOS = (Total Sales – BE Sales / Sales) * 100

= (3515 – 2157 / 3515) * 100 = 38.63%

In normal condition MOS of 30% or more can be regard as

adequate.
 Suggested format for BE Analysis
  Installed capacity per annum
  Production per annum
  Capacity utilisation
A. Production value / Sales
B. Variable expenses
  Raw materials
  Packing materials
  Consumable stores and spares
  Any others
C. Contribution (A-B)
D. Fixed and semivariable Expenses
1 Power and fuel
2 Wages and salaries
3 Repair and maintance
4 Other factory Overheads
5 Depreciation
6 Sales expenses
7 Distribution expenses
8 Intrest components
9 Admin expense
10 Rorality and know how
  Total Fixed expenses
E. Operating Profit ( C-D)
F. Break Even Sales
  (Fixed and semivariable Expenses *Production Volume) / Contribution
G. Break even at installed capacity
  (Fixed and semivariable Expenses * Capacity utilisation ) / Contribution
H. Cash break even at installed capacity

  (fixed and semivariable Expenses - Depreciation ) * Cap Util % / Contribution