Break Even Analysis

Break-Even analysis establishes the relationship among the factors affecting profit. Break-even point usually refers to the number of quantity for which a business neither makes a profit nor incurs a loss.

Fixed Cost

The cost which does not change with change in the volume of production. e.g. taxes, rent etc.

Variable Cost

These cost vary directly with output volume. It is assumed that the ratio between change in cost and change in the level of output remains constant.

Assumptions in Break Even Analysis:

• Selling price (S) will remain constant.
• Linear relationship between sales volume and cost.
• Production and sales quantity (Q) are equal.
•  No other factor, except quantity, will affect the cost.

Break Even Analysis

Let F : Fixed cost, V: variable cost per unit and if Q* is break-even quantity then

F + VQ*  = SQ*

\[Q* = \frac{F}{S-V}\]

Break- Even Point (BEP)

Angle of Incidence (θ)

This is the angle between the lines of total cost and total revenue. Higher is the angle of incidence faster will be the attainment of considerable profit for a given increase in production over BEP. Thus the higher value of θ makes the system more sensitive to changes near BEP.

                      

Profit Volume Ratio:

\[ \frac{S - V}{S}\]

Note: Higher is the profit volume ratio, greater will be the angle of incidence and vice-versa.

(S-V) is contribution margin/gross margin.

Profit Volume graph

Related Topics:

1. Forecasting

2. Queuing Models/Theory

3. PERT And CPM