In this article we will discuss about:- 1. Meaning of Break Even Charts 2. Significance of Break-Even Chart at Various Levels of Activity 3. Assumptions 4. Construction 5. Types 6. Advantages 7. Limitations.
Meaning of Break Even Charts:
‘Break even Chart’ is a graphical representation of marginal costing. It is considered to be the most useful graphic representation of accounting data. Break-even chart shows the inter relationship between cost, volume and profit. The graph clearly shows the break-even point and profit or loss at various volumes of activity.
Dr. Vance is of the opinion that “It is a graph showing amount of fixed and variable costs and sales revenue at different volumes of operation. It shows at what volume the firm first covers all costs with revenue and break-even.”
Significance of Break-Even Chart at Various Levels of Activity:
(1) The Break even chart shows the fixed costs variable costs and total costs.
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(2) The chart shows the sales units and sales value at which sales revenue is equal to total costs. In other words it shows the break-even point at which there is no profit or loss.
(3) The chart shows the Profit/Loss at various volumes.
(4) Margin of Safety is clearly shown.
(5) The chart also shows the Angle of Incidence which is the difference between total cost line and sales line on the graph.
Assumptions of Break-Even Charts:
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1. Costs are classified into fixed and variable.
2. Variable costs directly change in proportion to output.
3. Fixed costs remain constant at all levels of activity.
4. Selling price is same at different levels of output.
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5. No change in product mix.
6. Level of efficiency and management policy do not change.
7. There is no opening and closing stocks since the entire units produced are sold.
Construction of Break-Even Charts [How to Draw]:
The construction of break-even charts is explained below step by step:
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1. Co-ordinates on the graph are to be drawn first. The X axis represents output in units and the Y axis represent costs and revenue.
2. Suitable scales are to be selected for both units and amounts.
3. The sales volume or sales units are to be plotted. When plotted, the sales revenue or the output will be a straight line from origin to the right. If the scales on both the axes are the same, the sales line will be at 45° angle to the base.
4. The fixed cost line is to be drawn parallel to the ‘X’ axis to indicate that it is inelastic within the installed capacity.
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5. The total cost line is to be drawn for a given sales volume or units.
6. The point at which the total cost line intersects the sales line is the break-even point. A line drawn perpendicular to the ‘x’ axis from the break-even point represents loss and the area above the point, represents profit.
7. The angle formed at the point of intersection of the total cost and the sales lines is called the angle of incidence.
Types of Break Even Charts:
From the point of view of methods of preparation and purpose for which the chart is prepared, break even charts may be various types.
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Normally, following types are most commonly used:
1. Simple break-even chart
2. Contribution break even chart
3. Profit break even chart
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4. Profit chart for product-wise analysis
5. Cash break even chart, and
6. Control break even chart.
The above charts are briefly discussed below:
1. Simple Break Even Chart:
It is orthodox break even chart. Its preparation is simple.
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Normally cost and revenue are shown on Y-axis, while one or more of the following are shown on X axis:
(1) Quantity of sales (units).
(2) Value of sales (in rupees).
(3) Sales as percentage to capacity.
(4) Volume of production (units).
(5) Value of production (in rupees).
(6) Production as percentage to capacity.
Of the above, which should be shown in the chart depends on the purpose for which the chart is prepared. It is evident that profit cannot arise unless goods are sold. Therefore it is logical that sales are shown on X axis.
How to Draw a Break Even Chart?
Example 1:
A Ltd. has furnished the following details:
(2) Contribution Break Even Chart:
In the case of simple break even chart variable cost line is shown above the fixed cost line. Sometimes fixed costs can be shown above the variable costs. In such a case the chart is known as contribution break even chart. The specialty of this chart is that contribution is indicated clearly in the chart by way of difference between variable cost line and sales line.
Example 2:
Contribution Break Even Chart:
You are given the following data for the coming year of a factory:
3. Profit Break Even Chart:
This is also called profit graph. Break-even point can also be ascertained by means of this chart. Profit graph shows the profit/loss at different levels of output/sales. Sales units/rupees are plotted on the X axis and profit/loss is measured in y axis. Profit increases with increase in sales volume and decreases with decrease in sales volume.
Example 3:
Draw the profit – volume graph and find out P/V ratio with the following information:
From the illustration we find that the profit is Rs. 500 and the fixed cost is Rs. 500. So A line A-B has been drawn intersecting sales line at point ‘A’ which is the BEP, which can be read to be Rs. 1,250.
The P.V. Ratio can also be ascertained from this graph as follows:
4. Profit Chart for Product-Wise Analysis:
This chart is also termed as profit path chart. It is prepared in the case of business concerns which are engaged in the production of two or more products. It is prepared with the help of P/V Ratio.
5. Cash Break Even Chart:
Cash break even chart shows break-even point through graph, i.e., the amount of cash needed to break even. Thus this chart indicates the point at which cash inflow will be just equal to cash outflow.
Example 4:
A model of cash break even chart is given below:
6. Control Break Even Chart:
This chart is used for control purpose by the management. Control break even chart forms part of budgetary control system The main purpose of this chart is to compute budgeted variance in respect of sales, costs and profits, Control break even chart is prepared with the help of budgeted and actual data and thus it compares budgeted sales with actual sales and budgeted costs with actual costs, budgeted BEP with actual BEP and budgeted profit with actual profit and so on. To indicate the variance between budgeted figures and actual figures they are shown with distinct colours/marks.
Advantages of Break-Even Charts:
Break even charts are mainly used for analysing ‘cost-volume profit’ relationship. The break even charts are useful for an existing concern to venture for expansion and diversification and for a new concern for having a modest start of the new adventure by aiming at the break-even point.
The following are the advantage of break-even charts:
1. They present information in a simple form to analyse and understand the relationship between cost volume and profit.
2. They indicate profitability of products. Break even charts indicate profitability of various products and plants in addition to exhibiting the breakeven point.
3. Break even charts provide an insight into changes in the various factors affecting profit.
4. Break even charts serve as a tool of cost control as the structure of the total costs is shown very clearly. This will be helpful to the management to exercise decisions regarding control of cost.
5. They help in presentation of flexible budgets as the costs under both variable and fixed categories are analysed uniformly.
6. They are helpful in profit planning. Break even charts help by providing information for forecasting and long-term planning.
Limitations of Break Even Charts:
1. Assumption of break-even analysis that fixed costs remain constant and variable costs vary in proportion to output will not hold good in the long-run.
2. Assumption that all units produced are sold is wrong. In practice the business enterprise shall be having both opening and closing stocks.
3. Assumption regarding constant selling price is ridiculous as the prices are affected by demand and supply.
4. Management policy keeps changing due to several factors. This is ignored and it is assumed that policies of the management do not change.
5. Break even charts assume that product mix remains same; this may not hold good in the long-run.
6. The fundamental relationship of profit volume and cost can be easily understood by break-even analysis rather than by drawing break even chart.