Concept of break-even analysis

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Concept of break-even analysis:


To make a profit, the activities of a business organization are mainly conducted. Profits are earned when the amount of income is more than the expenses of the business. Profitability depends on the proper planning and foresight of the trader. Break-even analysis plays a helpful role in formulating profit plans. Through this, the data of profit/loss of the organization can be calculated.

Importance of Break-even Analysis:

Break-even analysis plays an important role in determining the right decision and course of action for the maximum profit of the organization.

The importance of Break-even analysis is briefly discussed below:

1. Profit planning:

Break-even analysis plays an important role in formulating short-term profit plans. If everything else remains unchanged, the change in the amount of production or sales will change the profit, it is known through Break-even analysis.

2. Commodity pricing:

How much it is possible to reduce the price of a commodity in a particular situation, at what price the maximum profit will be obtained by selling a commodity, is easily known through Break-even analysis.

3. Acceptance or Rejection of Supply Orders:

Whether it would be more profitable to accept excess supply orders through excess production than regular production and sales, Break-even analysis helps management to make the right decision.

4. Commodity production stops:

Variable costs increase as production increases, but fixed costs remain unchanged. As a result, if the selling price remains unchanged, the profit may increase. In many cases, production has to be reduced or stopped altogether. In such a case, which is profitable for the business, can be determined through break-even analysis.

5. Domestic or foreign new market selection:

Break-even analysis can make a significant contribution to making the right decision when it comes to selecting new markets for selling goods within the country or abroad to maximize profits.

6. Restoration decision:

Break-even analysis helps management to make effective decisions about whether it is profitable to replace a used machine with a new one. Finally, break-even analysis provides management with guidance on how to maximize profits.

Fixed cost and variable cost:

Fixed cost:

Expenditure that is fixed and does not change with the change of production activity in a given period i.e. does not increase or decrease the cost of production, is called fixed cost. In the words of the Institute of Cost and Work Accountants, “the costs that remain constant as a result of variations in production are fixed costs.”

Concept of break-even analysis. As the fixed cost remains unchanged despite the increase and decrease in production, the fixed unit cost decreases when the production increases, and the unit cost increases when the production decreases. Examples of fixed costs – salaries of administrative officers, insurance, buildings, rooms, etc.

Variable cost:

Expenses that vary directly with the amount of production are therefore variable costs. Variable costs fluctuate in proportion to the increase or decrease in production or efficiency. Costs increase proportionately as production increases and costs decrease proportionately as production decreases. Examples of variable costs – direct raw materials, direct labor, electricity costs, printing costs, etc.

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