Introduction and break even analysis

Module 1

What is OM?
Is a systematic approach to address all the issues pertaining to the transformation process that converts some inputs into output that are useful , and could fetch revenue to the organisation Input includes:
materials, labour and energy

Output includes
goods and services Goal is to minimise the cost and generate revenue in excess of cost

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Break even analysis(BEA)

Has considerable significance for
Economic research Business decision making Company management Investment analysis And public policy

Is an important technique to trace relationship between costs, revenue and profits at the varying levels of output or sales
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Break even point

Break even chart

TOTAL COST, TOTAL REVENUE

The break even point is located at that level of output or sales at which the net income or profit is zero. i.e. total cost is equal to total revenue

TR Break even point

Pr it of e on z

TC

Variable cost
s Lo s

TFC Fixed cost

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OUTPUT(SALES)

Break even analysis in terms of physical units

This method is convenient for the single product firm The break even volume is the number of units of the product which must be sold to earn enough revenue just to cover all expenses(fixed+ variable) Formula for calculating BEP is:
BEP =

fixed costs contribution margin per unit Where the contribution margin(PROFIT) is : selling price variable costs per u
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Break even point in terms of sales value

Multi product firms are not in a position to measure the break-even point in terms of any common unit of product Hence BEP found through total rupee sales
Fixed cost BEP = Contribution margin ratio CMR= TR-TVC TR

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Break even point as a percentage of full capacity

Full capacity can be defined as the maximum possible volume attainable with the firms existing fixed equipment, operating policies and practices. BEP is usually expressed as a percentage of full capacity
E.g.: suppose the full capacity of a firm is 10,000 units ,and having FC of Rs.10000 and VC of Rs 2/unit and the SP being Rs.4/unit , the BEP at 5000 units can be expressed as 50% of full capacity

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Multi product manufacturer and BEP

Most manufactures makes more than one product In such situations BEP is found differently

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Managerial uses of break even analysis

Capacity expansion decisions Product add or drop decisions Make or buy decisions Equipment selection decisions Production process selection decision

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Capacity expansion decisions

The management might often be interested in knowing whether to expand production capacity or not through the installation of additional equipment

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Drop and/or Add decision

A business manager confronted with the questions: is often following

1. Should a new product be added in view of its estimated revenue and cost? 2. Should a particular item be dropped from the product line and what would be its consequent effects on revenue and cost?

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Make or Buy decision

Many business firms often have the option of making certain components or ingredients which are part of their finished products or purchasing them from outside the suppliers
Fixed costs BEP Purchase price variable cost =

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Equipment selection decisions

Break even analysis can also be used to compare different ways of doing jobs E.g.: slow and simple machines for smaller quantities and fast and costlier machines for larger quantities Decision to choose best alternative

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Limitations of break even analysis

It is static
Assumed every thing to be constant

It is unrealistic
Based on many assumptions which do not hold good in practice

It has many shortcomings

Fails to consider the impact of technological changes, better management, division of labour, improved productivity, which influence profit

Scope is limited to short run only It is difficult to handle selling cost in the BEA
Selling cost does not vary only with the output

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