Production Management

The Uses of Break-even Analysis in Decision-making

This is the question that how ‘break-even analysis’ helps in effective business decisions. The answer may slightly vary depending on situations. The break even analysis is very useful in the area of managerial decision-making. Some important decision-making areas are as follows :

(1) Product planning.

(2) Make or buy decision.

(3) Equipment selection and replacement.

(4) Pricing of the products.

(5) Deciding the optimum product-mix.

(6) Deciding upon the most profitable distribution channel.

Some important applications of BEP analysis are as follows :

(1) Calculation of profit from different sales volumes :

Profit = S – (VC + F.C)

(2) Calculation on sales volume to produce designed profit :

F.C. + desired profit/PV Ratio

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

Contribution per unit = Fixed cost / Break-even point in units

And selling price per unit + Contribution per unit. + variable cost per unit

(4) Calculation of sales volume required to meet proposed expenditure :

Additional sales volume (in units) =Proposed Expenditure/Contribution per unit

(5) Determination of margin of safety : It can be expressed in the following three manners :

(i) M.S. = Total current sales – B.E. Sales

= Profit / P/V Ratio

= (Sales – B.E. Sales)/Sales x 100

(6) Calculation of sales volume required to offset price reduction.

(7) Change in sales volume or selling price to offset the impact of change in variable costs and fixed costs :

(i) When there is change in fixed costs

(ii) When there is change in variable costs

(8) Measuring the effect of Changes in Profit Factors – B.E. analysis helps in the measurement of effect of changes in various profit determining factors such as changes in selling price, variations in fixed costs, change in product-mix, etc.

(9) Choosing the Most Profitable Alternative – Break-even technique may be used to select the most profitable alternative between two.

(10) Determining the Optimum Sales Mix – This analysis is also useful for determining the best sales-mix which consist of personal selling, advertising and sales promotion. Suppose, a manufacturer is thinking of adding two salesmen to his sales- force. Or as an alternative he may think of spending USD. 1,00,000 on intensive advertising. What these new fixed costs will do to the break-even points can be shown by break-even analysis.

(11) Deciding Upon Change in Capacity – With the help of this technique we can decide whether change in capacity will be profitable or not.

Thus profit potentiality of addition or expansion can be ascertained with his technique.

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