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What is Break-Even analysis? How it can measure risk?


Break-Even Analysis: It is a point where total cost and total revenue intersect each other or we can say that total cost and total revenue is being equal. With the help of it we can calculate how many units of a product a company have to produce more to earn profit on it. In below diagram if we sold more than 9 units of a product at Rs.8.5 we earn profit otherwise incurred loss.





Break-Even Point (BEP) units = Total Fixed Cost/Sale price per unit –Variable cost per unit   
 
                                 OR

Break-Even Point (BEP) units = Fixed Cost/ Contribution Margin per unit

                                               OR

Break-Even Price = (Total fixed Cost/ Total Sales) +Variable cost per unit

Contribution Margin: It shows contribution in sales price which does not include variable cost. It is also called Gross profit but sometimes it is different from contribution margin because it includes variable cost and fixed cost too.

Contribution Margin per unit = Sales price per unit-Variable cost per unit

Contribution Margin Ratio = Contribution Margin per unit/ Sales price per unit

Break-Even Analysis helps to calculate margin of safety which measures risk. Higher the margin of safety better for the company.

Margin of Safety = (Total Sales Units-Break-Even Sales Units)/Total Sales Units

Example: Find out the Break-Even Point Units from the following information:

Fixed Cost = Rs.5000
Variable Cost per Unit = Rs.15
Sales per unit = Rs.25
Sold Units = 30,000

Solution: Break-Even Point (BEP) units = Total Fixed Cost/Sale price per unit –Variable cost per unit    
BEP units = 5000/25-15
= 500 units

Example: Find out the Break-Even Price where firm face neither profit nor loss with the help of following information:

Gross profit =Rs.98000
Cost of goods sold = Rs. 27000
Unit sold = 3500
Variable cost per unit=Rs.20
Total fixed cost = Rs.12000

Solution: 
Break-Even Price = (Total fixed Cost/ Total Sales) +Variable cost per unit
Sales = Gross profit + Cost of goods sold
Sales= Rs. (98000+27000)
Sales = Rs. 125000
Sales price per unit = 125000/3500 = 35.71
Break-Even sales price = (12000/35.71) +20
=Rs.356 

Example: Firm  A launches 600 unit’s new product B and whose contribution margin per unit is Rs.20 and fixed cost is Rs.9000.find out the output a firm must have to produce to cover its cost and also earn profit?

Solution:
 Break-Even Point (BEP) units = Fixed Cost/ Contribution Margin per unit
BEP units = 9000/20
=450 units

Margin of safety = (Total Sales Units-Break-Even Sales Units)/Total Sales Units
= (600-450)/600
= 25%

Firm A must have to produce minimum 450 units to cover its cost and profit on 600 units is 25%.

Example: Find out how much quantity is to be sold where firm earn no profit or no loss. The selling price of one unit is Rs. 40 and the fixed cost is Rs. 20, 000 and variable cost of one unit is Rs. 25.

Solution: Break even point : Revenue = Cost
Revenue = Rs. 40 per unit
Cost = Rs. 20, 000 + 25 per unit
Let’s assume number of unit as U then,
40 U = 20, 000 + 25 U
15 U = 20, 000
U = 1, 333
So, 1, 333 unit is to be sold where cost and revenue is equal.

Example: Find out the selling price if 1, 000 unit of a product is sold to reach break even point. The fixed cost is Rs. 30, 000 and variable cost is Rs. 15 per unit.

Solution: Break even point : Revenue = Cost
Let’s assume selling price as P then,
1, 000 P = 30, 000 + 15(1, 000)
P = 45
So, the selling price is Rs. 45 where firm earn no profit or no loss.

















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