Page 217 - DMGT409Basic Financial Management

Basic Financial Management

Notes

Did u know? What is Break Even Point?
Break even point is that volume of sales where the firm breaks even i.e., the total costs

equal total revenue.

It is, therefore, a point where losses cease to occur while profits have not yet begun. That is, it is
the point of zero profi t.
Fixed Costs
BEP =
Selling price – Variable costs per unit

Example:

Fixed Costs Rs 10,000
=
Selling price Rs 5 per unit – Variable costs Rs 3 per unit
Rs 10,000
Therefore, BEP = =5,000 units.
5 – 3
The conclusion that can be drawn from the above example is that sales volume of 5000 units will
be the accurate point at which the manufacturing unit would not make any loss or profi t.

Note Assumptions of Break Even Analysis

The break even analysis is based on certain assumptions, namely:

1. All costs are either perfectly variable or absolutely fixed over the entire period of
production but this assumption does not hold good in practice.
2. The volume of production and the volume of sales are equal; but in reality they
differ.
3. All revenue is perfectly variable with the physical volume of production and this
assumption is not valid.
4. The assumption of stable product mix is unrealistic.

14.2 Uses of Break Even Analysis

Break even analysis is a very generalised approach for dealing with a wide variety of questions
associated with profit planning and forecasting. Some of the important practical applications of

break even analysis are:
1. What happens to overall profitability when a new product is introduced?

2. What level of sales is needed to cover all costs and earn, say, ` 1,00,000 profit or a 14% rate
of return?
3. What happens to revenues and costs if the price of one of a company’s product is hanged?

4. What happens to overall profitability if a company purchases new capital equipment or
incurs higher or lower fixed or variable costs?

5. Between two alternative investments, which one offers the greater margin of profi t
(safety)?

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