|
Break-Even
Point
The
break-even point (BEP) is the point at which cost or expenses and revenue are
equal. Break-even point is a point at which total costs just equal or break
even with sales. This is the activity point at which neither profit is made
nor loss is incurred. Break-even point of an enterprise/firm is a point where
total revenue/sale proceeds/sale or output equals total cost.
Usefulness/Importance of Break-even analysis:
1. Fair knowledge about break even
analysis can help bankers/banking to examine loan proposal of a firm.
2.Break even analysis helps the bankers
in assessing working capital requirement of a unit.
3. This analysis helps in revealing clear
projections of profit planning of an enterprise at different production level
vis-à-vis the financial needs.
4. It also helps to find rate of return
on investment of capital at varying levels of production.
5. Break-even lies can be quite useful to
management in determining the need for action.
Assumptions of Break-even point:
1. Fixed costs will tend to remain
constant. In other words, there will not be any change in cost factor, such
as, change in property tax rate, insurance rate, salaries of staffs etc.
2. Price of variable cost factors, i.e.,
wage rates, price of materials, supplies, services etc.
3. Product specifications and methods of
manufacturing and selling will not undergo a change;
4. Operating efficiency will not
increase/decrease.
5. There will not be any change in
pricing due to change in volume, competition etc.
Limitations of Break-even analysis:
1. It may be difficult to segregate to
segregate cost into fixed and variable components;
2. It is not correct to assumption that
total fixed cost into fixed and variable components;
3. The assumption of constant unit
variable cost is not valid;
4. Selling price may not remain unchanged
over a period of time;
5. Break-even analysis is a short run
concept and has a limited use in long range planning.
Application/Necessities of Break-even analysis:
1. It helps to provide a dynamic view of
the relationships between sales, costs and profits.
2. A better understanding of break even,
for example, is expressing break even sales as a percentage of actual sales
can give managers a chance to understand when to expect to break even.
3. The break-even point is a special
case of Target Income Sales.
Contribution Margin(CM):
The
unit Contribution Margin (CM) is the quantity of unit sales price (P) minus
the quantity of unit variable cost (V) is of interest in its own right, it is
the marginal profit per unit, or alternatively the portion of each sale that
contributes to Fixed Costs. The break-even point can be more simply computed
as the point where Total Contribution=Total Fixed Cost.
Contribution Margin(CM) Ratio:
The
margin contribution can also be expressed as a percentage. The contribution
margin ratio, which is sometimes called the profit-volume ratio, indicates
the percentage of each sales dollar available to cover fixed costs and to
provide operating revenue. The contribution margin ratio is Contribution
Margin (CM) Ratio = Sales – Variable Costs/Sales.
|
|
Margin of Safety:
Margin
of safety represents the strength of the business. It enables a business to
know what is the exact amount it has gained or lost and whether they are over
or below the break-even point. Margin of safety=(Current output-BEP)
Implications of Margin of Safety:
A)
In the point of application to investing:
1.
Using margin of safety, one should buy a stock when it is worth more than its
price on the market.
2.
The margin of safety protects the investor from both poor decisions and
downturns in the market.
3.
A common interpretation of margin of safety is how far below intrinsic value
one is paying for a stock.
B)
In the point of application to accounting:
In
investing parlance, margin of safety is the difference between the expected
sales level and the break-even sales level. It can be expressed in the
equation from as follows:
Margin
of Safety = Expected/Actual Sales Level – Breakeven sales Level.
What is meant by sales mix? What assumptions are
casually made concerning sales mix in cost-volume profits (CVP) analysis?
Sales
mix is the components of Cost volume profit analysis.
CVP
analysis expands the use of information provided by breakeven analysis.
Assumptions:
1.
The behavior of both costs and revenue is linear throughout the relevant
range of activity.
2.
Costs can be classified accurately as either fixed or variable.
3.
Changes in activity are the only factors those affects costs.
4.
All units produced are sold.
5.
When a company sells more than one type of product, the sales mix will remain
constant.
Applications:
CVP
simplifies the computation of breakeven in break-even analysis and more
generally allows simple computation of target income sales. It simplifies
analysis of short run trade-offs in operation decisions.
Limitations:
CVP
is a short run marginal analysis, it assumes that unit variable costs and
unit revenues are constant which is appropriate for small deviation from
current production and sales and assumes a neat division between fixed costs
and variable costs through in the long run all costs are variable. For longer
term analysis that considers the entire life-cycle of a product one therefore
often prefers activity-based costing.
|
|
Problem: The Paduka Shoe Company sells five
different styles of ladies chappals with identical costs and selling prices.
The company is trying to find out the profitability of opening another store,
which will have the following expenses and revenues:-
Annual fixed expenses are:
Required:(1) Calculate the annual Break-even
point in units and in value. Also determine the profit or loss if 35,000
pairs of chappals are sold;
Required: (2) The
sales commission are proposed to be discounted, but instead a fixed amount of
Tk.90,000 is to be incurred in fixed salaries. A reduction in selling price
of 5% is also proposed. What will be the Break-even point in units?
Required: (3) It is
proposed to pay the store manager 50 paisa (Tk.0.50) per pair as further
commission. The selling price is also proposed to be increased by 5%. What
would be the Break-even point in units?
Required: (4) Refer
to original data, if the store manager were to be paid 30paisa (Tk 0.30)
commission on each pair of chappal sold in excess of Break-even point, What
would be the store’s net profit, if 50,000 pairs were sold?
Solution:Required 1:
BEP in units = Fixed Cost/Contribution margin per
unit
= 3,60,000/(30-21) = 40,000 units
The required BEP in
units 40,000.
Contribution margin = (Contribution
margin/sales)*100
=
(30-21)/30*100 = 30%
So Break even Value = Fixed cost/CM ratio
=
3,60,000/0.3 = 12,00,000 Tk.
The Break Even Value is Tk.12,00,000.
Now, we know,
Sales = Fixed cost + variable cost + profit or
(loss)
Profit or (loss) = Sales – (Fixed cost + variable
cost)
Profit or (loss) = (30*35,000) – (3,60,000 +
21*35,000)
Profit or (loss) = 10,50,000 – (3,60,000 +
7,35,000)
Profit or (loss) = - 45,000.
So, the loss is Tk.45,000.
Solution: Required 2:
New variable cost
= Tk.19.50
New fixed expanse = (3,60,000 + 90,000) =
Tk.4,50,000.
New selling price = 30 – (30*0.05) = Tk.28.50
So, BEP in units
= Fixed Cost/(Selling price per unit – Variable
cost per unit)
= 4,50,000/(28.50-19.50) = 50,000 units
The required BEP in
units 50,000.
The required BEP in sales volume = Total
unit*Sales price
= 50,000*28.50 = Tk.14,25,000.
|
|
Solution: Required 3:
New variable cost = Tk. (19.50+1.50+0.50) =
Tk.21.50
New selling price = 30 + (30*0.05) = Tk.31.50
So, BEP in units
= Fixed Cost/(Selling price per unit – Variable
cost per unit)
= 3,60,000/(31.50-21.50) = 36,000 units
New BEP in sale volume = 36,000*31.50 =
Tk.11,34,000.
Solution: Required 4:
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Problem: A newly formed company has
applied for a short term loan to a commercial bank for financing its working
capital requirements. You are requested by the bank to prepare an estimate of
the requirements of working capital for that company. The information about
the company is as under:
Estimated cost per unit of
production is:
Additional information:
You
may assume that production is carried on evenly throughout the year (52
weeks) and wages and overheads accrue similarly. All sales are on credit
basis only.
Required: Estimate the net working capital required for
the company.
Solution:
Estimation
of working capital requirements:
|
Problem: A proforma cost sheet of a
company provides the following data:
Estimated cost per unit of
production is:
The following is the
additional information available:
You
are required to prepare a statement showing the working capital needed to
finance a level of activity of 70,000 units of output. You may assume that
production is carried on evenly throughout the year (52 weeks) and wages and
overheads accrue similarly.
Solution:
Estimation
of working capital requirements:
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
No comments:
Post a Comment