## May 6, 2012

### PM0012 [Project Financing & Budgeting] Set2 Q1

Q.1 Explain Break-even analysis?

Ans:

Break Even Analysis
The break-even point or break even analysis is the specific point at which, gains equal the losses. A break-even point describe the time when, an investment makes a positive return. It is at this point that the total costs become equivalent to the total amount of revenues. At this point, there is no loss or profit incurred. This point is crucial for everyone who manages the business. Because, breakeven point is the lowest limit of profit where there are set prices and determined margins.

The Break-Even Chart
The break even chart is the pictorial representation of the costs at different stages of activity. This is the point at which there is neither profit nor is loss incurred. In figure 4.2, the line OA stands for the dissimilarity in income, at different stages of production activity. Line OB stands for the total of fixed costs in the business. As there is an increase in the output, uneven costs are incurred. In such a case, the total of the costs also increase.

Break-even analysis is one of the most effective tools, which are used in studying the connection between the fixed costs, variable costs, and the returns. Break-even analysis measures the production volume at a specific price provided, which is essential for covering all the expenses.

Fixed costs do not have direct association with the level of production. Fixed costs include reduction on machinery, costs of interest, taxes, and the overhead costs. Even if the business has a result, which is equal to zero or has a high output, the level of these fixed costs will be the same. The examples of fixed costs include rental and rates, depreciation, research and development, marketing costs, and administration costs.

Variable costs vary in direct association with the volume of result. This include the cost of sold commodities and the production costs like labor, electricity expenses, feed, fuel, veterinary, and irrigation. They also include other expenses that are associated directly with the production of a good or an asset. Total Variable Costs (TVC) is the total of the uneven costs for the specific production level or the output. The average variable costs are the variable costs for a unit of output, or TVC divided by units of output.

Returns are the performance gauge used in order to assess the competence of an investment or to make a comparison regarding the efficiency of a number of different savings. For example, a marketing person makes a comparison between two different products by dividing the revenue each product produces.

Semi-Variable Costs
The calculation of the difference between the fixed and variable costs is the most convenient method of dividing the business expenses. Some of the costs have a stable nature. But, there will be an increase in these costs while the results reach a certain stage. For example, when a particular business produces lower level of result and sales, it will not need the costs that are related to functions like human resource management and resource finance management. But, when there is a growth in the business, the business will require more reserves. If there is a rise in the production, there will also be an increase in the transport and warehousing. In such cases, we say that the cost is partially fixed and variable.

Benefits of Break-Even Analysis
The main prominent benefit of break even analysis is that it describes the association between expense, production volume, and returns. It also shows the changes in the association between fixed and variable costs, product prices, revenues and so on. The concept of break even analysis is useful, when it is used along with partial budgeting and capital budgeting methods. It also shows the lowest amount possible in a business, so that you can prevent mistakes in the project.

Limitations of Break-Even Analysis
All benefits mentioned above do not mean that break even analysis is devoid of any limitations.

Some of the limitations of break even analysis include:
Inappropriateness to the analysis of a multiple projects, at a single stretch.
Difficulty to categorize a cost as variable or fixed.
Tendency to make use of break-even analysis, often after a change in the cost and income functions.