BREAK-EVEN ANALYSIS

BREAK-EVEN ANALYSIS
tool used for decision making
shows effect of changes in costs or volumes on profits
shows impact of operating leverage
also called Break-Even Analysis or Cost-Volume-Profit Analysis or CVP Analysis

Vocabulary
fixed costs : costs that remain constant regardless of number of units produced
variable costs: unit production costs of product
total variable cost: function of volume and unit variable cost
total cost: total fixed costs plus total variable cost
profit: difference between total revenue and total cost

Assumptions of Break-Even Analysis:
1. one product is involved
2. everything produced can be sold
3. variable cost per unit is the same regardless of volume
4. fixed costs do not change with volume
5. revenue per unit is constant with volume
6. revenue per unit exceeds variable cost per unit

Contribution margin:
total contribution margin: the total sales revenue minus total variable costs
unit contribution margin: the difference between sales price and variable cost per unit

The Model
P= SPx VCx FC
=CMx FC

where
P= profit
SP= unit selling price
VC= unit variable cost
FC= total fixed costs
x= sales volume in units
CM= unit contribution margin=unit SP unit VC

Example
sales= 10 000 units
selling price 20 per unit
variable cost 7 per unit
fixed costs 124 800

Income Statement
Sales (10 000 units) 200 000
-variable costs 70 000
CM 130 000
-fixed costs 124 800
Profit 5200


The Break-Even Point (BE): Fixed expenses/unit contribution margin
P=(SP-VC)x-FC
0=(20-7)x-124800
x=9600 uninits

Target sales volume: Fixed expenses + Target profit/unit contribution margin
=FC + Desired profit/CM= 10667 units

Margin of Safety
Difference between the budgeted sales revenue (or units) and the break-even sales revenue (or units)
e.g 10000 units sold
BE = 9600 units
margin safety is 400 units or 400/10000= 4% margin of safety or
5200/130 000= 4 % margin of safety

CVP Graph
shows how costs, revenues and profits change as sales volume changes

Break-Even Analysis

CVP Analysis with multiple Products
weighted average unit contribution margin
BE = Fixed expenses/Weighted average unit contribution margin

Break-Even Analysis: Possible Uses
Sensitivity Analysis
Goal Seeking Approaches
What-If Analysis

Operating Leverage
The extent to which an organization uses fixed costs in its cost structure.
Measuring operating leverage:
contribution margin/profit before tax