This article will help you with a clear definition and meaning to Break-even Analysis, how the formulas are derived and the definition of terms like (1) Break-even Analysis (2) Break-even point in sales value and units (3) Targeted profit, etc… First, watch this introductory video before the second video in this summary because an idea of the two different formats will help you understand the key concepts in this topic.
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Break-Even Analysis is also known as Cost Volume Profit Analysis (CVP) is the study of the functional relationship between the TOTAL COST, SALES, and PROFIT. It tells the total cost of producing a particular thing/item/product and also sales and volume to produce and profit to get after production.
Cost Volume Profit Analysis is also known as Break-Even Analysis whereas BREAK EVEN POINT is the point at which there is neither profit nor loss. I.e. a point at which a firm or an organization did not make a profit or loss.
BREAK-EVEN POINT, in a nutshell, is a situation where sales equal total cost (no profit or loss).
Break-Even Analysis Formula and Application of CVP
Cost Volume Profit Analysis (CVP) can be applied in the following areas;
Break-Even Point (UNITS)
To determine the number of units to be produced in order to equate revenue with the cost.
Break-Even Point (NAIRA)
To determine the revenue that must be earned in order to equate the total cost.
Break-Even Point (UNITS) for a Desired or Targeted profit
To determine the number of units to produce and sell in order to earn the desired profit.
Break-Even Point (NAIRA) for a Desired or Targeted Profit
To determine the revenue that must be earned in order to achieve the desired profit.
Margin of Safety
To determine how far will the revenue of an organization falls or drops before they start to make a loss.
MOS (UNITS) = Budgeted Unit – Breakeven Point (UNIT)
MOS (NAIRA) = Budgeted Unit – Breakeven Point (NAIRA)
Assumptions of Break-Even Analysis
- No Inflation.
- No technological renovation.
- The variable cost can be determined/ascertained and will remain varied throughout the level of activity.
- No opening or closing work in progress.
- It assumes linearity.
- Fixed costs can be determined and will remain the same throughout production.
- The mixed cost could be separated into two. I.e. fixed cost and variable cost.
There are different methods for solving BREAK-EVEN questions. The formulas in this article are based on solving the break-even point using “per unit” cost or value.
To help you derive the values to represent your fixed cost and variable cost, follow the clue or guideline below and always note that;
- Variable cost deals with cost per unit.
- Anything direct is a variable cost.
- Anything/value the question gives you as a variable cost is treated as a variable cost.
- Fixed cost deals with the total value.
- Indirect cost and any overhead cost are treated as fixed costs except the question specifies that it is a variable cost.