Page 269 - DMGT403_ACCOUNTING_FOR_MANAGERS

Accounting for Managers

Notes
3. Margin of safety can be found out in two ways
(a) Margin of Safety = Actual sales – Break even sales
= 15,000 – 9,000= 6,000

Profit 3,000
(b) Margin of Safety = 6,000
PVratio 50%
4. Sales required to earn profit = 6,000/-
To determine the sales volume to earn desired level of profit

Fixed Cost + Desired Profit
PV ratio

4,500 + 6,000
21,000
50%

12.6 Methods of Break-even Analysis

The break even analysis can be performed by the following method:

12.6.1 Break-even Chart

The difference between Price and Average Variable Cost (P – AVC) is defined as ‘profit
contribution’. That is, revenue on the sale of a unit of output after variable costs are covered
represents a contribution toward profit. At low rates of output, the firm may be losing money
because fixed costs have not yet been covered by the profit contribution. Thus, at these low rates
of output, profit contribution is used to cover fixed costs. After fixed costs are covered, the firm
will be earning a profit.
A manager may want to know the output rate necessary to cover all fixed costs and to earn a
“required” profit of R. Assume that both price and variable cost per unit of output (AVC) are
constant. Profit is equal to total revenue (P.Q.) less the sum of Total Variable Costs (Q.TVC) and
fixed costs. Thus
= PQ – [(Q. AVC) + FC]
R
= TR – TC
R
The break even chart shows the extent of profit or loss to the firm at different levels of activity.
A break even chart may be defined as an analysis in graphic form of the relationship of production
and sales to profit. The Break even analysis utilises a break even chart in which the Total
Revenue (TR) and the Total Cost (TC) curves are represented by straight lines, as in Figure 12.3.

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