Lesson no 20

***** Lesson no 20 *****

Let us understand the concept of Break Even Point (BEP)
As per Cost Accounting principles The Total Costs(Expenses) be classified as 1 Fixed Costs- FC
and 2 Variable Costs - VC
TC = FC+VC
1 Fixed Costs -
are those which do not change despite the variation in production of number of units. These costs are are Rent, Administration costs,Fixed Selling expenses, Fixed exp. on Royalties /Know how, Regular Maintenance costs ,Salaries and wages of office staff,Depreciation(Straight line method ie fixed), Interest on Term Loans etc. Although the level of production ie number of units manufactured differ the fixed costs remain same. Even if the no of units produced are zero still the cost has to be incurred.
Thus per unit Fixed costs changes as number of units produced changes.

2 VARIABLE Costs -
They vary with number of units produced. e g if Production is zero VC,will be zero. The cost of RM, Consumables, Labour, Power and fuel, Packing, Other varible rxpences for sales, Interest on Working Capital and such other costs those move with number of units produced. Thus the Unit Variable costs remains Constant.
P B E P --
BEP is a point ie Number of Units or Volume of Sales at which all Fixed costs are recovered . Let us Understand concept of Contribution (C) as per Cost Accounting concept.
C= Selling Price - Variable Costs

I) BEP Units =
(FC/Contribution per Unit)
= FC/SP - VC
II ) BEP in sales volume=
BEP in units*Selling price
III) BEP = FC/(P/V ratio in %)

Eg For a Manufacturing unit
Capacity of production in Units= 20000 units per annum ; Fixed Costs are Rs. Rs2.50 lacs; Selling Price per Unit = Rs120/- ; Variable Costs per Unit= Rs90/-
(Thus for every unit of production there will be recovery of Rs30/- towards fixed cost).
Say No of units produced in
Year 1=5000;Y 2 = 8500;Y 3= 10000
BEP units = FC/SP- VC
=2,50,000/120-90=8334 Units
Thus Break even will be in 2nd Year of production.
BEP in Volume of turnover or Sales
=8334*120 =Rs10,00,000/
Concept of P/V ratio
It is a ratio which shows the relationship between Cost,Volume and Profit(CVP).Higher the PV ratio higher will be profitability. It can be increased by increase in the Contribution ie by increase in SP or decrease in VC.

PV ratio = Contributions/Sales
= (S- VC)*Sales%= (120-90)*120= 25%

BEP = FC/PV ratio

= 2,50,000/25% = Rs10 lacs
BEP analysis shows us at what point the unit will break even.
PV ratio help us to find Level of Sales to :-
1Avoid losses,
2 To Achieve desired level of profit.
3 The effect of change in price, cost and volume
4 Which product is profitable out of several products.
5. Should the product be manufactured or bought from outside.
Remember the key is best P/V ratio.

Eg :- In the above case what should be the Sales Volume to earn a profit of Rs 50,000/-

P/V ratio= (FC+P)/Sales

25%= (250000+P)/S
S= 250000+50000/25%= 12,00,000
Or in units Sales should be 10,000 Units.

(Another ratio of PVC relationship is PV ratio = Change in profit or contribution/ Change in Sales).

Use these mathematical relationships to determine the requisite information.

Good by.
Waman Gokhale