Break-Even Analysis

1. Break-Even Analysis COURSE LECTURER: DR. O. J. AKINYOMI Break-Even Analysis by Dr. Oladele John AKINYOMI is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.

2. Definition • Breakeven analysis is also known as cost-volume profit analysis • Breakeven analysis is the study of the relationship between selling prices, sales volumes, fixed costs, variable costs and profits at various levels of activity

3. Application • Breakeven analysis can be used to determine a company’s 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

4. Assumption of breakeven point analysis • 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 cost • Total fixed cost are assumed to be constant in total • Variable cost • Total variable cost will increase with increasing number of units produced

5. Sales revenue • The total revenue will increase with the increasing number of units produced

6. Cost N Total cost Variable cost Fixed cost Sales (units) Total Cost/Revenue N Sales revenue Profit Total cost Sales (units) BEP

7. Calculation method

8. Calculation method • Breakeven point • Target profit • Margin of safety • Changes in components of breakeven analysis

9. Breakeven point

10. Calculation method • Contribution is defined as the excess of sales revenue over the variable costs • The total contribution is equal to total fixed cost

11. Formula Breakeven point Fixed cost = Contribution per unit Sales revenue at breakeven point = Breakeven point *selling price

12. Alternative method: Sales revenue at breakeven point Contribution required to breakeven = Contribution to sales ratio Contribution per unit Selling price per unit Breakeven point in units Sales revenue at breakeven point = Selling price

13. Example • Selling price per unit N12 • Variable cost per unit N3 • Fixed costs N45000 Required: • Compute the breakeven point in units and in Naira value

14. Breakeven point in units = Fixed costs Contribution per unit = N45000 N12-N3 = 5000 units Sales revenue at breakeven point = N12 * 5000 = N60000

15. Alternative method Contribution to sales ratio N9 /N12 *100% = 75% Sales revenue at breakeven point = Contribution required to break even Contribution to sales ratio = N45000 75% = N60000 Breakeven point in units = N60000/N12 = 5000 units

16. Target profit

17. Formula No. of units at target profit Fixed cost + Target profit = Contribution per unit Required sales revenue Fixed cost + Target profit = Contribution to sales ratio

18. Example • Selling price per unit N12 • Variable cost per unit N3 • Fixed costs N45000 • Target profit N18000 Required: • Compute the sales volume and sales value required to achieve the target profit

19. No. of units at target profit Fixed cost + Target profit = Contribution per unit N45000 + N18000 = N12 - N3 = 7000 units Required to sales revenue = N12 *7000 = N84000

20. Alternative method Required sales revenue Fixed cost + Target profit = Contribution to sales ratio N45000 + N18000 = 75% = N84000 Units sold at target profit = N84000 /N12 = 7000 units

21. Margin of safety

22. 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

23. Formula Margin of safety = Budget sales level – breakeven sales level Margin of safety = Margin of safety Budget sales level *100%

24. Sales revenue Total Cost/Revenue $ Profit Total cost Sales (units) BEP Margin of safety

25. Example • The breakeven sales level is at 5000 units. The company sets the target profit at N18000 and the budget sales level at 7000 units Required: Calculate the margin of safety in units and express it as a percentage of the budgeted sales revenue

26. Margin of safety = Budget sales level – breakeven sales level = 7000 units – 5000 units = 2000 units Margin of safety = Margin of safety Budget sales level = 2000 7000 = 28.6% *100 % *100 % The margin of safety indicates that the actual sales can fall by 2000 units or 28.6% from the budgeted level before losses are incurred.

27. Changes in components of breakeven point

28. Example • Selling price per unit N12 • Variable price per unit N3 • Fixed costs N45000 • Current profit N18000

29. If the selling prices is raised from N12 to N13, the minimum volume of sales required to maintain the current profit will be: Fixed cost + Target profit Contribution to sales ratio N45000 + N18000 = N13 - N3 = 6300 units

30. If the fixed cost fall by N5000 but the variable costs rise to N4 per unit, the minimum volume of sales required to maintain the current profit will be: Fixed cost + Target profit Contribution to sales ratio N40000 + N18000 = N12 - N4 = 7250 units

31. Limitation of breakeven point

32. Limitations of breakeven analysis • Breakeven analysis assumes that fixed cost, variable costs and sales revenue behave in linear manner. However, some overhead costs may be stepped in nature. The straight sales revenue line and total cost line tent to curve beyond certain level of production

33. 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 information for small and relatively simple companies that produce same product. It is not useful for the companies producing multiple products Break-Even Analysis by Dr. Oladele John AKINYOMI is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.