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  • September 26, 2022
  • Last Update March 12, 2022 2:43 pm
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5. BREAK EVEN ANALYSIS

We are visiting explore break-even analysis and appearance at the subsequent aspects:

  • Definition
  • Fixed and variable costs
  • Assumptions
  • Example of technique
  • Nonlinear break-even analysis

The break-even point is that the point at which the business neither makes a profit nor incurs a loss. it’s the purpose at which the overall of fixed and variable costs is precisely offset by the revenues. Of course, you would like to make a profit, that the goal is often to get revenue beyond the break-even point. as an example, many kids founded lemonade stands.

Assume their parents bought the wood for the stand, built the stand, and bought the sign, pitchers, glasses, and ready-mix. The little entrepreneurs sell five glasses at 25¢ and are pleased with their profit of $1.25. However, their parents know they spent $20 to line up the business and their initial costs haven’t been recovered.

They realize that 80 glasses must be sold to recover the investment and no profit are made until the 81st is glass sold, and even then the complete 25¢ received per glass isn’t profit. In fact, the business must sell quite 80 glasses to approach profit because the 80 glasses covered only initial fixed costs. Revenues from the initial sales contribute partially to recovery of the fixed costs and partly to the variable costs related to each glass of lemonade.

Break even analysis is that calculation which shows how any units of our product must be sold to hide the initial fixed costs and also the variable costs related to each of these items up to it point.

Beyond that time, which is where we would like to be, each unit sold has a part of the revenue recovering the variable costs related to it and also the other part is profit. this is often so because the fixed costs are recovered at the reach point, and now we are beyond that time, into the realm of PROFIT.

Fixed and Variable Costs

It is appropriate to categorize fixed and variable costs in order that the difference is clearly understood. Some samples of fixed costs are:

  • Executive and office salaries
  • General office expenses
  • Insurance
  • Property taxes
  • Interest
  • Depreciation of plant and equipment

Some samples of variable costs include:

  • Costs of products sold
  • Factory labor
  • Sales commissions
  • Raw materials used
  • Direct labor
  • Sales expenses

The key points are:

  • Fixed costs are those which you incur no matter whether or not you produce and/or sell any item. Take a glance at the list.

The items thereon (and some others you will think about for your own business or department or division) are things on which you’re spending money irrespective of whether you are doing or don’t produce a product. This cost could be a single number that’s associated with your company and/or your line of products. it’s not expressed as “per unit” because it’s not associated with the amount of units.

  • Variable costs relate on to the amount of units, and thus are expressed as “per unit.” Take a glance at “raw materials used,” the foremost recognizable variable cost. Obviously, the more items produced, the more raw materials used that must get replaced. this is often why variable costs are expressed perunit. during this discussion, a variable cost is constant per unit.

Presenting this idea yet another way, when the variable cost is constant per item and therefore the total cost varies with the quantity of items produced, the variability is with the change of total cost supported the amount of things produced.

The fundamental break-even analysis • is predicated on an assumption that all manufactured product is sold, i.e., no inventory remains unsold.

  • Another assumption isn’t any price breaks. While an organization sets a particular price that it sells product on one unit basis, it’ll allow a price break or discount for giant quantity purchases. this happens essentially but isn’t included in our discussion here.
  • We also assume that variable costs are constant (despite the seeming contradiction in terms). This doesn’t occur in point of fact because overtime pay, factory labor and bonuses for exceeding production, and other expenditures will change the variable costs. Again, for purposes of simplicity, we assume that variable costs remain constant per unit.
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