Page 219 - DMGT409Basic Financial Management

Basic Financial Management

Notes 5. It is difficult in practice to distinguish between variable and fixed decision costs, particularly,

when the distinction is drawn in the light of a specific problem situation and not in general

terms.
6. A single fixed cost level clearly implies that the analysis is concerned with a situation

within a single given plant capacity. If volume in excess of that limit is to be considered,

then the same level of fixed costs would not be appropriate.
14.5 Methods of Break Even Analysis

The sales volume which equates total revenue with related costs and results in neither profi t
nor loss is called Break even Point (BEP). Break even point can be determined by the following
methods:

14.5.1 Algebraic Method

Algebraic Methods
(i) Contribution Margin Approach
Fixed cost
Break even Point (units) =
Contribution per Unit
Fixed cost
Break even point (`) =
P/V ratio
OR = Break even units × Selling price p.u.

Contribution
P/V ratio = × 100
Sales
Fixed cost + Desired profit
Desired sales = P/V ratio
Desired sales or profi t or fixed cost or to know variable cost we can use following equation

i.e.,
Sales X P/V Ratio – Total Fixed Cost – Profi t
At Break even point
Contribution = Fixed cost
Contribution – Fixed cost = 0

(ii) Equation Technique
It is based on an income equation i.e.
Sales – Total costs = Net profi t.
Breaking up total costs into fixed and variable,

Sales – Fixed costs – Variable cost = Net profi t

Sales = Fixed costs + Variable cost + Net profi t
i.e. SP(S) = FC + VC(S) + P.
where
SP = Selling price per unit

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