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Part I : Background
1.1 Definition of Breakeven Analysis
Breakeven analysis is also known as cost-volume-profit analysis.
It is the study of the relationship between selling prices, sales volumes, fixed costs,
variable costs and profits at various levels of activity.
1.2 Application of breakeven analysis
Breakeven analysis can be used to determine a companys breakeven point (BEP).
Breakeven point is a level of activity at which the total revenue is equal to the total costs.
At this level, the company makes no profit. With reference to the breakeven point, the
managers can set their sales goals and target profits.
1.3 Assumption of breakeven analysis
The model of breakeven analysis is developed on the following assumptions:
Relevance rangeIt is assumed that a company is operating within a relevant range.
The relevant range is the range of an activity over which the fixed cost will remain
fixed in total and the variable cost per unit will remain constant.
Fixed costsTotal fixed costs are assumed to be constant in total. Fixed costs per
unit will decrease with the increasing number of units produced.
Variable costsVariable costs per unit are assumed to be constant. Total variable
costs will increase with the increasing number of units produced.
Sales revenue ---Sales revenue per unit is assumed to be constant and the total
revenue will increase with the increasing number of units produced.
These assumptions are illustrated in the following diagrams:
Costs ($)
Total Costs
Variable costs
Fixed costs
Sales (Units)
Total cost/ Revenue ($)
Sales Revenue
Profit
Total costs
Sales (units)
BEP
Part II : Breakeven Analysis
2.1 Breakeven point
Breakeven point is the level of activity at which the company makes neither profit nor loss.
It is also the activity level at which the total contribution is equal to the total fixed costs.
Contribution is defined as the excess of sales revenue over the variable costs.
Contribution
Fixed costs
Variable costs
=
Breakeven point units =
2.3 Target Profit
No. of units at target profit =
Fixed
costs
+
Target
Contribution per unit
Profit
2.3.1 Example 2
Selling price per unit --$12
Variable cost per unit -- $3
Fixed costs-- $45,000
Target profit-- $18,000
You are required to compute the sales volume required to achieve the target profit.
No. of units at target profit =
Fixed
costs
+
Target
Contribution per unit
Profit