Recent Project and Job Topics > Finance

Break Even Analysis

Break even analysis

Companies come into business to gain profits and realize them after they have successfully taken the required risks. The break-even point is that point where revenue equals costs that were incurred to receive this revenue.

For example, if a company is selling less than 100 pens in a month, it will make a loss. If there are more than a 100 pens sold in the month, it makes a profit. Thus, the company uses various strategies and tools to be able to sell more than a 100 pens a month to make a profit. The break even analysis shows that if the company manager keeps a strategy to sell more than a 100 pens a month, the company will sustain profits throughout the year.
At the break even point, the firm begins to experience no income and no loss. The CVP or the cost volume profit analysis begins at a point indicating that total revenues equal total costs. Here, the costs are the total of fixed and variable costs.

If the company intends to remain at the break even point, on a break even analysis, the company should try to:

- Lower fixed costs (like rent, phone bills etc)

- Lower variable costs (higher expenses for attracting customers)

- Increase the selling price of the product or service.

Break even analysis is analyzed on the supply side where only the costs of the sales are analyzed and not the demand being affected by the price levels.

Break even analysis is the simplest analytical tool that helps provide an overview into the dynamic relationships of sales, costs and profits.

There are various limitations to the break even analysis, which are that:

- Break even analysis is a supply-side analysis and has nothing to do with sales variations.

- Break even analysis works well in the short run as the increase in the scale of production may increase the fixed costs.

- Break even analysis also assumes that variable costs are constant for every unit.

- Break even analysis assumes that the amount of goods produced is equal to the amount of goods sold.

Cost volume profit analysis or CVP Analysis

In this form of cost accounting, the CVP analysis succeeds the break even analysis. Cost volume profit analysis assumes the same elements as in break even analysis. These are:

- Costs' and revenues' behavior is linear throughout the timeframe of the activity.

- Fixed and variable costs are present.

- Only factors affecting costs are the change in activity.

- There are no goods in the inventory and all goods are sold.

- After selling more than one product, the ratio of each product to the total sales will be constant.

CVP analysis or Cost Volume Profit analysis requires the following components:

- Level of activity or volume of activity
- Variable cost per unit
- Unit selling Prices
- Total Fixed Costs
- Sales mix

Profit analysis or CVP analysis or Cost Volume Profit Analysis considers the following assumptions:

- A constant sales mix
- A constant total fixed cost
- A constant sales price
- A constant total fixed cost
- A constant variable cost per unit
- Unit sold equals unit produced
This form of profit analysis has linear assumptions as it entails elementary discussions on profits and costs. Nevertheless, as the cost accountant advances with the treatment of the profit analysis after the break even analysis, the costs and revenue become non-linear in nature and the profit analysis is more complex.