One Of The Limitations Associated With Break-even Analysis Is That

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Read on to learn how a break-even analysis can help you better understand business.

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What Is Break-Even Analysis?

Break-even analysis is the relationship between cost volume and profits at various levels of activity, with an emphasis placed on the break-even point. This point is where the business receives neither a profit nor a loss, when total money received from sales is equal to total money spent to produce the items for sale.

Advantages and Uses

Break-even analysis enables a business organization to:

Measure profit and losses at different levels of production and sales.
Predict the effect of changes in sales prices.
Analyze the relationship between fixed and variable costs.
Predict the effect of cost and efficiency changes on profitability.

Disadvantages

Even with its advantages and uses, there are also several demerits of break-even analysis.

Assumes that sales prices are constant at all levels of output.
Assumes production and sales are the same.
Break even charts may be time consuming to prepare.
It can only apply to a single product or single mix of products.

Formulas

There are two ways to calculate the break-even point, in units and in sales revenue.

The first way is to divide the fixed cost by the contribution per unit. This gives the result in units.
Divide the fixed cost by the contribution-to-sales ratio. This gives the sales revenue.The contribution-to-sales ratio is given by dividing the contribution per unit by the selling price per unit.

Example of a Break-Even Point

ABC Ltd expects to sell 10,000 units at $10 each. The variable cost per unit is $5 and the fixed cost is $15,000 per annum. Calculate the break even point in units and in sale revenue.

To calculate the break-even point in units, use the formula-fixed cost divided by the contribution per unit. In this example you would divide $1,000 by contribution (which is the selling price of $10 minus the variable cost per unit of $5). $15,000 divided by $5 is 3000 units
To calculate the break-even point in sales revenue, divide the fixed cost by the contribution-to-sales ratio. In this example, $15,000 divided by ($5 divided by $10, or .5). The final answer is $30,000. We know this is the correct answer because when we multiply the break-even point in units by the selling price, we get the same answer.

Business Example:


Fictional Company
Unit selling price:	$36
Unit variable expenses:	$28
Total fixed expenses:	$50,000
Actual sales:	7,000 units

A break-even chart is a graphical representation of the break-even point, profits, losses and margin of safety. Using information from the example above, we will create a chart that shows:

fixed cost
total revenue line
margin of safety
loss region
total cost line
break-even point
profit region

Work out the total revenue by multiplying the unit selling price by the actual sales: 36 × 7,000 = 252,000
Work out the total cost by multiplying the unit variable expenses by the number of units sold and adding that to to the fixed expenses: 28 × 7,000 = 196,000 + 50,000 = 246,000
Now set up your chart. Note that when plotting, the first number in brackets is the x (horizontal) axis value and the second digit after the comma is the y (vertical) axis value. For this chart, you will show total unit sales along the x axis in thousands. Along the y axis you will show sales in tens of thousands of dollars, since there were 7,000 units sold and $50,000 in total sales.
Now draw the fixed cost line. Make a dotted line from (0, 50,000) to (7,000, 50,000).
Next you will make the Total Revenue line. Plot a point at (7,000, 252,000) and draw a line from zero to that point. Label the line.
To create the Total Cost line, plot the point (7,000, 246,000) and draw a line from (0, 50,000) to that point. Label the line.
Where the two lines meet is called the Break-Even Point and should to be labeled as such. The region below the break-even point should be labeled the Loss Region. The region above the break-even point should be labeled the Profit Region.
Draw a dotted line from the break-even point to meet the x axis. From where it touches the x axis, to the actual sales, is the Margin of Safety in Units.
To illustrate the margin of safety in dollars, draw a dotted line from the break-even point to the y axis. From where the line touches the y axis, to the total revenue line, is the Margin of Safety in Dollars.

The finished chart showing a break-even analysis for a fictional company.

This article is accurate and true to the best of the author's knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

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Why breakeven analysis can work only for single product

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i don't really understand the advantages

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i have learnt how to plan for a certain company

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good stuff

Ted Smith on January 06, 2015:

I really like this break even analysis. It really helps you see how much profit you are making or how much money you are losing. I should do this with my business. I might need to have an accountant help me though. I'm not the best at math.

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what is the disadvantage of break even

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Consolacion Miravite from Philippines on April 13, 2014:

Breakeven analysis is a fairly easy concept to understand. It is harder to learn in school than to apply it in actual work situations. What this just means is that --- at what level of sales do you need to recoup all your expenses? Say, if your total cost/expenses amounts to $10 and your unit sales price is $2 ----- BEP (Breakeven point) is 5 units. Meaning, after selling 5 units, all incremental sales would be profit.

This is a big help in business. Especially the small trade stores and outlets that does not have much financial muscle. Good hub!

GUD JOB BRO on June 03, 2013:

BUT THERE IS ANOTHER DISADVANTAGE AND ITS THAT:

Break even charts are constructed assuming that all goods produced by the firm is actually sold - the graph does not show the possibility that stocks may build up if not all goods are sold

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thank you so much guys didn't know about the limitations of breakeven analysis nd diddnt know that it has some merits and demerits......thank you so much now i understand so much bout da topic

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THANX GUYZ

MOZIEY OBY CHINS on October 30, 2012:

THANX GUYZ

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BizVT34 from USA on February 21, 2012:

Good stuff on break-even. However, I like to pair it with a cash flow forecast. I'v seen many businesses that were break-even go bankrupt because they run out of cash. Here's a 30 Second biz lesson on cash flow https://hubpages.com/business/Cash-Flow-vs-Profit...

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Thankyou very much for the valueable information. i now know that the breakeven point is the point at which the revenue and the cost lines intersects. moreover i now the adventages and the dis adventages that it has.

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