Production Management

Advantages and Limitations of Break-even Analysis

Significance or uses or advantages of break-even analysis in decision-making are discussed below. B.E. analysis helps managers in a number of ways. Some noteworthy uses of this analysis are as follows :

Uses of Break-even Analysis

(1) Calculation of profit for different sales volumes.

(2) Calculation of sales volume to produce desired profit.

(3) Calculation of selling price per unit for a particular break-even point.

(4) Calculation of sales volume required to meet proposed expenditures.

(5) Determination of sales required to offset price reduction.

(6) Measurement of effect of changes in profit factors.

(7) Choosing the most profitable alternatives.

(8) Determining the optimum sales mix.

(9) Deciding on changes in capacity.

Thus we see that break-even analysis is a useful management guide. It helps the management in determining the most profitable prices for the products of an enterprise. It helps the management in the optimization of profits and maximum utilization of resources. In a nutshell, the break-even analysis technique provides a fillip to the management to accelerate the volume of production to earn maximum profit.

Limitations of Break-Even. Analysis

The break-even analysis is based on a number of assumptions which are rarely found in real life. Hence, its managerial utility becomes limited. Its main limitation are as follows :

(1) The first and foremost limitation of the break-even analysis is that both cost and revenue should be taken into account to determine the break-even point. The one without the other has no meaning. But this analysis assumes that prices do not change while in actual life, prices do change as a result of several factors, e.g., change in demand, fashion style, etc.

(2) It assumes that all the costs can be divided into fixed and variable costs; that they vary in a linear fashion and that the principle of cost variability applies to them. All these assumptions do not hold true.

(3) This analysis ignores the time lag between production and sales. The quantum of production may be kept constant, but the sales are bound to vary from period to period. This feature of sales reduces the significance of the break-even analysis as a management guide.

(4) Factors like plant-size, technology and methodology of production have to be kept constant in order to draw an effective break-even chart. But it is not found in actual life.

(5) The sales-mix too is not a constant variable.

(6) This analysis does not take into account the capital employed in the production and its costs which is an important consideration in profitability decisions.

(7) The valuation and allocation of costs in a company are usually arbitrary. So it reduces the utility of this analysis.

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