Introduction:
The
determination of the breakeven point of a firm is an important factor in
assessing its profitability. It is valuable control technique and a planning
device in any business enterprise. It depicts the relation between total cost
and total revenue at the level of particular output. Ordinarily the profit of
an industrial unit depends upon the selling price of product (revenue), volume
of business (it depends on price) and cost price of the product.
Breakeven
point
Breakeven
point is an important measure being used by the proponents and banks in
deciding the viability of a new project, especially in respect of manufacturing
activities. This technique is useful dealing with a new project or a new
activity of the existing unit.
The
Breakeven point (BEP) establishes the level of output / production which evenly
breaks the costs and revenues. It is the level of production at which the
turnover just covers the fixed overheads and the unit starts making profits.
From
the banker’s point of view, the project should achieve a break – even position
within a reasonable time from the start of production. The project which
reaches a break – even point earlier is considered as viable project by
bankers. They cannot only expect earlier repayment of their advances in the
case of such projects but can also be assured that the project can fairly adapt
itself to the day – to – day developing technology. The projects which are
unlikely to reach the breakeven point in the third or fourth year of its
commencement of production will be not be viable proposal for the bankers.
The
break even analysis also determines the margin of safety, i.e. excess of
budgeted or actual sales over the break – even sales so that the bankers would
know how sensitive a project is to recession. This is an important factor in
determining the feasibility of the project and its ability to absorb the ups and downs in the
economy. The bankers, as lenders of funds, insist upon a reasonable margin of
safety so that fixed costs are met a fairly earlier stage.
Utility
of break even analysis:
The
utility of break – even analysis is as follows:
1.
It serves as the most
useful and important managerial tool to study cost output – profit relationship
at varying level of output.
2.
It is useful in
reviewing pricing policies.
3.
It aids in planning
capitalization of the enterprise.
4.
It provides the entrepreneur
to decide whether to acquire or not assets involving additional fixed costs.
Shortcomings
of the Break – Even analysis:
The
BEP analysis is based on some assumptions, such as sales prices, costs,
production, sales etc. The technique will be only of financial value unless all
these assumptions are well – calculated. Besides the technique is a preliminary
and supplementary tool in the whole exercise of ratio analysis.
Another
important factor in using the technique is to provide cost – escalation as a
built – in safeguard against increase in process.
The
most important factor while using technique, however is the proper analysis of
various costs into fixed costs and variable cost as there are some types of
costs which do not fall into either of the categories. These are the expenses
which are partly fixed and partly variable. In a breakeven analysis these semi
– fixed costs cannot be treaded independently but have to be isolated into the
usual categories of fixed and variable elements.
Break
even analysis may not prove useful to rapidly growing enterprise and to
enterprises which frequently change their product mix.
It
has limited utility in the case of multi products
It
does not take due cognizance of factors like uncertainty and risk involved in
estimates of costs, volume and profits.
It
is not a potent tool for long range planning.
Irrespective
of these shortcomings inherent in the usage of this technique it is an import
tool for the profitability analysis of the new project.
