Page 267 - DMGT403_ACCOUNTING_FOR_MANAGERS

Accounting for Managers

Notes PV ratio at the level of one unit
10
PV ratio 100 50%
20
From the above workings, it is obviously understood that every unit of sale contributes 50%
towards in covering the fixed cost and profit.

12.5.2 Advantages of Break-even Analysis

The main advantages of using break even analysis in managerial decision making can be the
following:
1. It helps in determining the optimum level of output below which it would not be profitable
for a firm to produce.

2. It helps in determining the target capacity for a firm to get the benefit of minimum unit
cost of production.
3. With the help of the break even analysis, the firm can determine minimum cost for a given
level of output.
4. It helps the firms in deciding which products are to be produced and which are to be
bought by the firm.

5. Plant expansion or contraction decisions are often based on the break even analysis of the
perceived situation.
6. Impact of changes in prices and costs on profits of the firm can also be analysed with the
help of break even technique.
7. Sometimes a management has to take decisions regarding dropping or adding a product
to the product line. The break even analysis comes very handy in such situations.
8. It evaluates the percentage financial yield from a project and thereby helps in the choice
between various alternative projects.
9. The break even analysis can be used in finding the selling price which would prove most
profitable for the firm.

10. By finding out the break even point, the break even analysis helps in establishing the
point wherefrom the firm can start payment of dividend to its shareholders.

12.5.3 Limitations of Break-even Analysis

The following are the key limitations of break-even analysis:
1. Break even analysis is generally used to find out the output level at which the total fixed
cost of a company are covered up by the contributions. But due to non-availability of
separate data for fixed and variable cost for each product manufactured by the company
the analysis had to be carried out with respect to time.
2. The analysis itself has got some inherent limitations which have been mentioned earlier.
3. The company considered manufacturing a wide range of products and is operating at
various locations. Hence, to carry out the analysis at company scale is a very complex
procedure which involves sorting of relevant data from a heap of data and then compiling
it in the form required by the analysis. Generally companies don’t differentiate very
clearly and hence don’t record costs on the basis of fixed and variable cost.

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