Break Even Analysis

Prepared By : Jitendra Singh Gill (Top educator on UNACADEMY, Ex- Scientific Officer BARC, Ex-Faculty
member MADE EASY and NEXT IAS ), for GATE/ESE Aspirants
Break-Even Analysis
 Break-even Analysis is also known as cost volume profit analysis.
 The major objective of the cost volume profit analysis is to identify
the smallest output level necessary to secure a nonnegative level
of profit.
 In Break even analysis total cost has mainly two components that
is fixed cost and variable cost.
 Fixed cost are the costs that are not associated with the size of
production or sale of products. They are a function of time, not
sales or production, and therefore, they are incurred whether or
not the firm produces anything or sells any product. Typical
examples of FC are rent, lease payments, insurance premiums,
regular utilities, executive and clerical salaries, and debt services.
 Fixed cost is represented by horizontal line on the break-even
analysis graph.
 Variable cost are any costs that are associated with the size of
production or sale. They fluctuate up and down with the volume or
production in a positive relationship. Typical examples of VC are
production material, production labour and production utilities
such as the cost of electricity and gas consumed by the productive
machines and equipment, merchandise insurance, transportation
and storage.
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 where is break even quantity, is selling price

per unit item and is variable cost per unit item.
 where is cash break even quantity and NC
is any non-cash charges constituting ad sizeable portion of the FC.
Non-cash charges are the depreciation charges, which have to be
deducted from the operating FC in order to prevent the
overestimation of the break-even point
 Break even revenue (BER)
1 /
 Contribution Margin (CM): The CM is the amount of profit earned
on each unit sold above and beyond the break-even quantity and
similarly, it would be the amount of loss the firm would incur on
each unit produced below the break-even point. Mathematically,
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 Margin of Safety: It is the difference between the operating sales

and break-even sales.
!"!#$ "%&!" !%' !(!# "%&!"
)% *+# ,- "%-!$.
 )% *+# ,- "%-!$. %$+,
!"!#$ "%&!"
 Higher margin of safety Means that in case of little fall in
production, the firm will keep earning profit.
 Production volume (0) for a targeted profit ( )
3 +5
2
 Angle of incidence: This is the angel between the lines of total cost
and total revenue.
 Higher is the angle of incidence, faster will be attainment of
considerable profit for given increase in production over BEP. Thus,
the higher value of 6 makes system more sensitive to changes near
break-even point.
%&!" % +%;&! <,"$
7 89:
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 Higher is the profit volume ratio, greater will be angle of incidence
and vice-versa.
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 Profit volume graph
 Effect of change of various variable on BEP.

Variable Direction of Change Break Even Output
Total fixed cost (e.g., Up Up
cost of equipment) Down Down
Average variable cost Up Up
e.g., cost of material Down Down
Product price Up Down
Down Up
 Break Even Analysis between two alternatives

Break even analysis is a powerful analytical tool, which uses simple
graphical technique to compare few feasible alternatives. It is useful for
analyzing cost/revenue relationship with respect of production volume
Let, = Fixed cost for process 1
> Fixed cost for process 2
= Variable cost for process 1 (per unit item)
> Variable cost for process 2 (per unit item)
Break -even-quantity
? Total cost of manufacturing at break-even-quantity,
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 Leverage is profit sensitivity to the variability of the product sales.

 If Fixed cost (FC) is larger than Variable cost (VC) for a firm then the
firm is said to be highly leveraged.
 Profit elasticity is interpreted as the precent change in profit due
to a 1% change in output. An applicable formula for profit elasticity
is
%∆ ( )
@ C@ C
%∆ ( )
Where is Q is production quantity
 Profit elasticity is also known as degree of operating leverage
(DOL).
 The DOL of 2 means that for every 1% change in sales, operating
income would change by 2%.
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 Any increase in Fixed cost would make the denominator smaller

and the DOL larger and any decrease in fixed cost would make the
denominator larger and the DOL smaller. We can then conclude
that the higher the firm’s fixed operating cost, relative to its
variable cost, the greater the degree of operating leverage and
ultimately higher the profit.
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Break Even Analysis

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Prepared By : Jitendra Singh Gill (Top educator on UNACADEMY, Ex- Scientific Officer BARC, Ex-Faculty

member MADE EASY and NEXT IAS ), for GATE/ESE Aspirants

 where is break even quantity, is selling price

 Margin of Safety: It is the difference between the operating sales

 Profit volume graph

 Effect of change of various variable on BEP.

 Break Even Analysis between two alternatives

 Leverage is profit sensitivity to the variability of the product sales.

 Any increase in Fixed cost would make the denominator smaller

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