Theory Of Cost And Break Even Analysis Pdf
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The below mentioned article provides a complete overview on Break-Even Analysis. The break-even point refers to the level of output at which total revenue equals total cost.
- Theory of Cost and Break Even Analysis
- Chapter 15 – Cost-volume Profit (CVP) Analysis and Break-Even Point
- Break-Even Analysis (explained with diagram) | Financial Management
Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" costs that change when the production output changes and those that are "fixed" costs not directly related to the volume of production. Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss the "break-even point". In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income or sales, revenue with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:.
Theory of Cost and Break Even Analysis
In managerial economics another area which is of great importance is cost of production. The cost which a firm incurs in the process of production of its goods and services is an important variable for decision making. Total cost together with total revenue determines the profit level of a business. In order to maximize profits a firm endeavors to increase its revenue and lower its costs. Costs play a very important role in managerial decisions especially when a selection between alternative courses of action is required. It helps in specifying various alternatives in terms of their quantitative values. Future costs are those costs that are likely to be incurred in future periods.
CVP analysis requires that all the company's costs, including manufacturing, selling, and administrative costs, be identified as variable or fixed. Key calculations when using CVP analysis are the contribution margin and the contribution margin ratio. The contribution margin represents the amount of income or profit the company made before deducting its fixed costs. Said another way, it is the amount of sales dollars available to cover or contribute to fixed costs. When calculated as a ratio, it is the percent of sales dollars available to cover fixed costs. Once fixed costs are covered, the next dollar of sales results in the company having income. The contribution margin is sales revenue minus all variable costs.
Break- Even point is a very significant concept in Economics and business, especially in Cost Accounting. Break- Even point is a point where the cost of production and the revenue from sales are exactly equal to each other; which means that the firm has neither made profits nor has incurred any losses. The Break- Even Analysis is also known as the Cost- Volume- Profit Analysis and is used to study the relationship between total cost, total revenue, profits and losses. It also helps to determine that level of output which is required to cover the operating costs of a business. Break- Even analysis is a concept used very widely in the production management and costing.
Chapter 15 – Cost-volume Profit (CVP) Analysis and Break-Even Point
However, business decisions are generally taken on the basis of money values of the inputs and outputs. Inputs multiplied by their respective prices and added together give the money value of the inputs, i. An opportunity to make income is lost because of scarcity of resources. Income maximizing resource owners put their scarce resources to their most productive use and thus they forego the income expected from the second best use of the resources. Thus, opportunity cost may be defined as the expected returns from the second best use of the resources that are foregone due to the scarcity of resources. It is also called alternative cost. The concept of business costs is similar to the actual or real costs.
The Break-even analysis or cost-volume-profit analysis c-v-p analysis helps in finding out the relationship of costs and revenues to output. It enables the financial manager to study the general effect of the level of output upon income and expenses and, therefore, upon profits. This analysis is usually presented on a break-even chart. It helps in understanding the behaviour of profits in relation to output. Such an understanding, among other things, is significant in planning the financial structure of a company.
CVP analysis looks at the effect of sales volume variations on costs and operating profit. The analysis is based on the classification of expenses as variable expenses that vary in direct proportion to sales volume or fixed expenses that remain unchanged over the long term, irrespective of the sales volume. Accordingly, operating income is defined as follows:. A CVP analysis is used to determine the sales volume required to achieve a specified profit level. Therefore, the analysis reveals the break-e ven point where the sales volume yields a net operating income of zero and the sales cutoff amount that generates the first dollar of profit.
Break-Even Analysis (explained with diagram) | Financial Management
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