Production Management

Break-even point | Contribution | Margin of Safety | Profit Volume Ratio

Break-even point – The point at which the total cost and the sales intersect each other is called the break- even point. In other words, the break-even point of a company is the level of sale income which will equal the sum of its fixed costs and its variable costs.

Thus, it is the point of ‘no profit no-loss’. It has been defined by G.R. Crowningshield as follows : “Break-even point is the point at which sales revenue equals the cost to make and sell the product and no profit or loss is reported.”

In the words of Charles S. Horngreen-“The break-even point is that point of activity (sales volume) where the revenues and total expenses are equal. It is the point of zero profit and zero loss. “

The knowledge of break-even point is very useful for the management. It is calculated by the following formula :

BEP = Fixed cost/ (Sale Price-Variable Cost)

BEP = Fixed Cost / P/V Ratio

The break-even point can also be calculated by means of a chart.

Contribution – Contribution is the difference between the sales price per unit and the marginal cost per unit. It contributes towards fixed expenses and profit. Suppose in one case the selling price per unit is USD.10 and variable cost is USD.7 per unit. Now, in this example, contribution is USD.3 per unit. If fixed cost is USD.30,000, the break-even sale will be 10,000 units. (30,000/3).

Thus, contribution first goes to meet fixed costs upto b.e. point and then to earn profit.

Margin of Safety – It is the difference (excess) between the current actual sales and break-even point output. As per formula :

Margin of safety = Total Sales – B.E.P. sales.

On the break-even chart, this is represented as the distance between the break-even point, and the present production or sales, can be expressed as percentage of total sales also.

For example. if the current sales of a firm are USD. 5,00,000, its B.E.P. sale is USD. 3,00,000-. Hence, its margin of safety will be USD. 2,00,000 (USD. 5,00,000-USD. 3,00,000). It can be expressed at 40% also.

It can be calculated with the help of the following formula also :

Margin of safety = Profit / P/V Ratio

If the margin of safety is large, it is an indicator of the strength of a business because with a substantial reduction in sales of production, profit shall be made. On the other hand, if the margin is small, a small reduction in sales production will be a serious matter because actual sales volume is just equal to the break-even sales.

The following steps may be taken to improve unsatisfactory safety.

1. Increase the level of production.

2. Increase the selling price.

3. Reduce the fixed or variable costs or both.

4. Substitute the existing products by more profitable products.

The margin of safely is the excess of budgeted or actual sales over the break-even sales —Charles T. Horngren

Profit-Volume Ratio – It is generally known as P/V Ratio. It is a relationship or percentage of contribution in terms of sales or turnover. It can be calculated as follows :

P/V Ratio = Contribution / Sales × 100

P/V Ratio plays a very important part in the solution of problems sought to be dealt with by the break-even analysis. It is very helpful pricing policy, product analysis and break-even point etc.

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