Page 221 - DMGT409Basic Financial Management

Basic Financial Management

Notes Assumptions regarding Break even Charts

1. Costs are bifurcated into variable and fi xed components.
2. Fixed costs will remain constant and will not change with change in level of output.
3. Selling price will remain constant even though there may be competition or change in
volume of production.

4. The number of units produced and sold will be the same so that there is no operating or
closing stock.
5. There will be no change in operating effi ciency.

6. In case of multi-product companies, it is assumed that the sales mix remains constant.
7. Variable cost per unit will remain constant during the relevant volume range of graph.

Note Steps Involved in Construction of Break Even Chart
1. Select a scale for sales (units) on horizontal axis.

2. Select scale for costs and revenues on vertical axis.
3. Draw the fixed cost line parallel to the horizontal axis.

4. Draw the total cost line, starting from the point on the vertical axis which represents
fi xed costs.

5. Draw the sales line, starting from the point of origin (zero) and finishing at point of
maximum sales.
6. The sales line will cut the total cost line at the point where the total cost equal to total
revenues.
7. The point of intersection of two lines is called ‘break even point’ i.e., the point of no
profit no loss.

8. The lines drawn from intersection to horizontal axis and vertical axis give the sales
value and number of units produced at break even point.
9. The loss is shown if the production is less than the break even point and profi t is
shown if the production is more than the break even point.
10. The total sales minus break even sales represent the margin of safety.
11. The angle that the sales line makes with total cost line, while intersecting it at break
even point is called ‘angle of incidence’.
Illustration 1: From the following data, calculate the break even point by means of a break even
chart:

Selling price per unit = ` 15
Variable cost per unit = ` 10
Total fixed cost = ` 1,50,000

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