Contribution Analysis and Break-Even Point (BEP) or Cost-Volume-Profit (CVP) Analysis
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FINANCIAL MANAGEMENT: THEORY AND PRACTICE
INTRODUCTION
This chapter discusses the components of fixed and variable costs; Break-even profit (BEP) and its algebraic,
Arithmetical presentations and its Expressions. Contribution Analysis ant its other uses.
FIXED COSTS AND VARIABLE COSTS
‘Break-even Point’ is that specific stage where the income just breaks even with expenditure, i.e. where income
just equals cost. It is, thus, the point of ‘No Profit No Loss’.
For the purpose of this analysis, the total cost is divided into the following two parts:
(i)Fixed Cost (FC)
(ii)Variable Cost (VC)
Fixed Cost is that part of the total cost which remains constant; that is, which does not vary with the
fluctuations in the volume of production. Even if the volume of production is high, low, or even ‘nil’, the fixed
cost is, necessarily and unavoidably, incurred and, at the same fixed level, e.g. rent and taxes, depreciation,
salary and wages (as also interest on capital, expense on research and development, advertisement, which
usually fluctuate, too, but not necessarily in the proportion of the volume change).
The interest component on term loans for plant and machinery, land and building, and depreciation thereon
(except on land), have to be incurred, whether there is full (to the capacity) production, or lesser production,
or even no production. Such is the case with the salary and wages paid to the members of the staff, who are
on the establishment of the unit. It has to be paid whether there is production at the level of 100 per cent of
the plant capacity or 50 per cent of the capacity, or even at the zero level. These costs are fixed and they are
incurred, definitely and necessarily, and hence are called ‘Fixed Costs’.
Variable Cost, on the other hand, is that part of the cost which varies in direct proportion to the volume of
production. For example, raw materials, consumable stores and spares, electricity charges for factory, fuel,
packing materials.
Let us assume that the bodies of 100 numbers of fountain pens consume 100 g of plastic granules. If we were
to produce 1,000 units, the raw material consumed would be 1,000 g or 1 kg. If we produce 500 numbers, the
raw material consumed will be 500 g or ½ kg. Similarly, if we decide not to produce pen bodies (say today), the
raw material consumed would be ‘nil’.
There, however, may be such costs, which are in the nature of being partly fixed and partly variable also.
Accordingly, such costs are referred to as semi-variable costs.
ALGEBRAIC PRESENTATION OF BREAK-EVEN-POINT
Let us now understand the concept algebraically.
At Break-even Point (BEP)
Total income = Total expenditure
or
Total sales (Revenue) = Total cost
or
Total sales (Revenue) = Fixed cost + Variable cost
or Q × S = F + (Q × V)
where Q = Total sales quantity
S = Unit selling price
F = Fixed cost, and
V = Unit variable cost
Thus, QS = F + QV
or F = QS – QV
or F = Q (S – V)
CONTRIBUTION ANALYSIS AND BREAK-EVEN POINT (BEP) OR COST-VOLUME-PROFIT (CVP) ANALYSIS
459
or at BEP
Q (S – V) = F
or Q =
F
S−V
F
or
Q=
C
where C stands for Contribution. Contribution here represents the selling price per unit (less) variable cost per
unit. That is, S – V is also known as the Contribution.
Thus, the difference between the selling price per unit and the variable cost per unit first goes to meet the fixed
cost. When the fixed cost is fully met, out of the contribution so generated, we are deemed to have reached the
BEP. Further, the sale of the unit(s) hereafter, and only hereafter, constitutes the profit. Not earlier; because,
it entirely goes to meet the fixed cost. Some people tend to confuse ‘Contribution’ with ‘Profit’, and land up in
trouble, after starting the unit.
Example 1:
A person approached a banker with a proposal for a loan of ` 2 lakh to purchase a car to ply it as a taxi. He was
visibly over-excited about the proposal, as it had appeared to him to be so fantastically profitable.
He went on to say:
‘Look, one litre of petrol today costs ` 40, and presuming that in one litre petrol, the brand new car gives
20 km., the cost comes to ` 2 per km. But I would charge ` 4 per km. Thus, I would earn a profit of ` 2 per km.
In other words, a profit of ` 2 on every investment of ` 2. A cent per cent profit indeed! How wonderful! Isn’t
it?’, he asked.
‘No, sorry. It is not so’, the banker told him politely, knowing fully well that this statement will definitely
upset him.
The banker further explained ‘The ` 2 that you are deeming to be profit, is not really profit. It is only
contribution, instead. First, it has to go to meet the fixed cost, which you have not at all taken into account.
Then, the quantum of contribution, if left after meeting the fixed cost in full, will only qualify to be computed
as profit, and not any earlier’.
‘To understand the concept of ‘fixed cost’ and ‘contribution’ more clearly, let us visualize the fixed cost as the
depth and volume of a ditch. The contribution per unit has to be first dumped in this ditch. When the ditch is
full to the brim, then alone it will mean that the fixed cost is fully met’.
‘The very next unit contribution will constitute profit. The more you will operate your taxi hereafter; the
quantum of your profit will continue to increase, proportionately’. ‘Now, let us see what would be the quantum
of fixed cost in your case. That is, even when you do not ply the taxi a single km, this is the cost that you will
have to incur, on an annual basis.
‘Let us, for example, presume the following fixed costs:
`
(i)Interest on term loan, say, for ` 2 lakh at 12 per cent per annum.
24,000
(ii)Depreciation on the car as per the Straight linear method at 10 per cent.
20,000
(iii)Rent for a garage at ` 100 per month.
1,200
(iv)Salary to the Driver at ` 10,000 per annum.
10,000
(v)Registration and Insurance charges
4,000
(vi)Servicing charges and minor repairs
800
Total fixed costs
60,000
‘Thus, if you ply the taxi for 30,000 km only, you just break even, i.e.. you arrive at the ‘no loss no gain’ position.
If you do not get sufficient business to ply even 30,000 km, and you get business for doing only 15,000 km,
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FINANCIAL MANAGEMENT: THEORY AND PRACTICE
instead, you incur a loss of ` 30,000 (i.e. ` 60,000 – ` 30,000). If you are, however, able to push the business
upto 32,000 km. you earn a profit of a mere ` 4,000 only (` 64,000 less ` 60,000).
‘Then, if you want to earn a minimum profit of ` 20,000 per year, you must book the business of minimum
40,000 km. Also, if you find that you would not be able to book the business for so much, this proposal of yours
would be a losing one, or at least, not so profitable.
‘In that case, I am sure, you would like to reconsider the proposal. If, for example, you prefer to purchase
an old car, instead of the new one, say, for ` 25,000, the fixed cost may go down substantially and you may be
able to break even much earlier, i.e. at a much lower level of operation’.
Let us work out an example.
Example 2:
A company, engaged in the manufacture of pens, sells the pens at ` 20 per unit. The variable cost per unit comes
to ` 12 and the fixed cost is computed at ` 10,000. Calculate the BEP in terms of:
(i)Number of units to be sold, and
(ii)Total value of sales.
Solution
(i)BEP =
F
10, 000 10, 000
=
=
S − V 20 − 12
8
(S – V = Contribution)
(ii)Total value of sale = 1250 units × ` 20 = 25,000
ARITHMETICAL PRESENTATION OF BEP
S is the selling price per unit
V is the variable cost per unit
F is the fixed cost
Thus, the BEP is reached either at the sale level of 1,250 units, or when the volume of sales (in terms of
value) reaches ` 25,000 (125 × ` 20 = ` 25,000).
Let us now try to understand the concept by means of a simple arithmetical calculation, as has been computed
hereunder:
F CProfit/(Loss)
(Fixed Cost)
(Contribution)
If only one unit would have been produced
– 10,000
+
8
=
–
9992
and sold, the result will be F – (S – V) or F – C
If 100 units are sold
– 10,000
+
800
=
–
9,200 loss
If 1,000 units are sold
– 10,000
+
8,000
=
–
2,000 loss
If 1,250 units are sold
– 10,000
+ 10,000
=
– + ‘Nil’ No profit
or loss
BEP No profit
or loss
If 1,500 units are sold
– 10,000
+ 12,000
=
+
2,000 Profit
If 2,500 units are sold
– 10,000
+ 20,000
=
+
10,000 Profit
The aforesaid concept can as well be presented in the form of a diagram appearing in Fig. 22.1.
As can be seen in Fig. 22.1 below, at the Stages 1 and 2, the black dots represent the quantum of contribution
(sales revenue less variable cost) generated (this has gone to fill only a portion of the ditch of the fixed costs).
Accordingly, the white portion represents the quantum of loss still remaining, which indicates the portion of
the fixed costs still lying uncovered.
CONTRIBUTION ANALYSIS AND BREAK-EVEN POINT (BEP) OR COST-VOLUME-PROFIT (CVP) ANALYSIS
Stage 1
Stage 2
Stage 3
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Fig. 22.1 BEP Presentations
Further, it is only at the Stage 3 that the entire ditch of the fixed costs has been completely filled up. This
goes to indicate that at this point, the entire fixed costs have been recovered in full, and, accordingly this is the
point where the company is neither making any loss, nor any gain or profit. This is the point of ‘No Profit-No
Loss’, which as we all know, has rightly been termed as the ‘Break-Even Point’. From this stage onwards, any
and every quantum of the ‘Contribution’ will go to make, and add on and on, to the quantum of profit of the
company, but not earlier.
VARIOUS EXPRESSIONS OF BEP
BEP can well be expressed in various ways. For example, in terms of:
(i)Volume of production
(ii)Sales revenue
(iii)Plant capacity
(iv)Selling price
(v)Make or buy decision
(vi)Profit projection
(vii)Selling efforts
(viii)Sales incentive plans
(ix)Product pricing decision
Let us take an example where the installed capacity of a plant is 25,000 units per year.
Example 3:
Fixed cost = ` 30,000 per year
Selling price = ` 10 per unit
Variable cost = ` 7 per unit
(i)BEP in terms of Volume of Production will be:
F
30, 000
30,000
or
or
= 10,000
S−V
3
10 − 7
(ii)In terms of Sales Revenue, BEP will be:
10,000 × ` 10 (Selling Price) = ` 1 lakh
(iii)In terms of Plant Capacity percentage:
(Given: At the level of production at 25,000 units, the plant capacity utilisation is 100 per cent)
∴ At the level of production of 1 unit, the plant capacity utilisation will be
100
25, 000
∴ At the level of production at 10,000 units, the plant capacity utilisation will be
100 × 10, 000
25, 000
That is to say that the BEP is reached at 40 per cent of the plant capacity. As the zone of profit starts
only after reaching the break-even point, we may as well say that there is still some scope for profit to the
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FINANCIAL MANAGEMENT: THEORY AND PRACTICE
extent of 60 per cent of the installed capacity remaining unutilized [Total plant capacity – BEP (in terms
of capacity)].
Margin of Safety
If the BEP is reached at an earlier level (say, at 30 per cent) of the installed capacity, the additional scope of
profit becomes greater (70 per cent). If the BEP is reached at much higher level (say, at 70 per cent), the scope
for profit diminishes (i.e. 30 per cent). Thus, we may fairly conclude that lower the BEP, greater is the ‘Margin
of Safety’. That is, even if the sales (and the resultant production) were to go lower and lower, the units at lower
BEP would not run the risk of incurring losses till that point. Also, even if the production and sales were very
low, the chances of the unit incurring losses will be smaller. Reverse will be the case if the BEP were to be at
higher level, i.e. in terms of plant installed capacity.
Example 4:
To bring home the idea of ‘Margin of Safety’ more clearly, let us take the case of two companies A and B, with
different margins of safety as under:
Company A
Company B
Total installed capacity
1,00,000
60,000
Break-even sales
50,000
50,000
Break-even point is reached at per cent capacity
50%
83.33%
Margin of safety, therefore, is
50%
16.67%
Thus, company A is in a better position, or we can say, in a safer position, because even at 60 per cent level
of production and sales, company A will earn some profit, but company B will incur heavy losses. In fact, the
process of incurring losses in the case of company B will set in, the moment the production and sales go below
the level of 83.33 per cent, whereas in the case of company A, this eventuality will arise much later, i.e.., when
the production and sales drop below 50 per cent, and not earlier.
(iv) Selling Price
Break-even point (BEP) can also serve as a tool to fix the minimum acceptable selling price at a particular level
of sales (and production). Let us Consider Example 2.
(a)If the company decides to produce and sell 15,000 units,
F + QV
= Price (at the BEP)
No. of units
30, 000 + (15, 000 × 7) 30, 000 + 1, 05, 000 1, 35, 000
=`9
=
=
15, 000
15, 000
15, 000
(b)If the level of sales (and production) is 20,000, the minimum acceptable selling price would be ` 8.50
only.
30, 000 + (20, 000 × 7) 30, 000 + 1, 40, 000 1, 70, 000
= ` 8.50
=
=
20, 000
20, 000
20, 000
But, remember. The price so fixed is at the break-even point.
If we want to fix the selling price so as to result in a gross profit of say, ` 50,000 per year, at the level of
production of 20,000 units, the price should be fixed at ` 11, computed as following:
F + QV + Profit
= Price
No. of units
30, 000 + (15, 000 × 7) + 50, 000 30, 000 + 1, 40, 000 + 50, 0000
=
20, 000
20, 000
2, 20, 000
= ` 11
20, 000
CONTRIBUTION ANALYSIS AND BREAK-EVEN POINT (BEP) OR COST-VOLUME-PROFIT (CVP) ANALYSIS
463
But then, if we cannot increase the price due to competitive market beyond say, ` 10, and we also wish to
retain our annual profit at ` 50,000 per annum, we may as well do so by increasing our production and sales:
F + QV + P (Profit)
= No. of units
Price per unit
Let the number of units be X
30, 000 + ( V × X ) + 50, 000
=X
10
30, 000 + 7 X + 50, 000
or
=X
10
or
10X = 30,000 + 7X + 50,000
or
3X = 30,000 + 50,000
\
80, 000
or
X=
= 26,667 units
3
(i.e. 26,666.6 units converted into the next integer or whole number)
But the installed capacity is only 25,000 units. Therefore, either the company will have to remain satisfied
with a profit of ` 45,000 (instead of ` 50,000) or will try to reduce the variable cost or fixed cost at the planning
and project stage itself. But then, the production at a level, which is higher than the installed capacity by say,
5 per cent to 7 per cent or even up to 10 per cent, is generally considered rather normal.
Example 5:
A small scale unit in Meerut, manufacturing nuts and bolts, had installed the plants and machinery worth
` 2 lakh purchased from Ludhiana. Most of the processes of production were automatic. But the minimum price
at the break Contribution even point itself was ` 50 per unit. But the other manufacturers of Ludhiana were
able to sell the nuts and bolts of the same size and specifications even at Meerut at a much lower unit price
of ` 40. It was, in fact, possible for the Ludhiana manufacturers to do so only because they had not installed
expensive automatic machines but the much cheaper hand-operated ones. Thus, the fixed cost was of a much
lower order. Therefore, the BEP was reached much earlier, leaving a wide range of the margin of safety. As the
Meerut unit had not done the BEP analysis at the project formulation stage itself, it had to pay a very heavy
price for this. This unit had to close down and sell away the machines, etc., at a throw away price. At the end,
it ended up with a net loss of ` 2 lakh.
As there are many variables in the study and computation of BEP, e.g. FC, VC, Selling Price, Plant Capacity,
Quantum of Profit, Volume of Sales and Production, we may vary one variable and then witness the changes
that take place in respect of the other variables, as also the end results.
We may even programme the computer suitably and get the results quickly, by varying one variable after
the other. Such a study could serve as a very valuable managerial tool for taking vital decisions in the matters
of pricing policy, launching a project, deciding about the level of production, among other things.
(v) Make or Buy Decision
BEP also helps us to decide whether a particular component of a product, or a particular processing in the chain
of production process, could be got done from outside (on a job-work basis) or it should also be manufactured
in-house, by the firm itself.
This is popularly known as ‘Make or Buy’ decision.
(vi) Profit Projection
Contribution analysis is an important tool to project the quantum of profits at different levels of activity.
Consider the following data:
(a)No. of units sold, say,
:
100
Sales @ ` 10 each
:
`1,000
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FINANCIAL MANAGEMENT: THEORY AND PRACTICE
Variable costs at ` 6 each
Contribution per unit ` 4 (10 – 6)
Fixed costs say,
:
:
:
`600
`400
`300
Profit
:
`100
(b)If the company increases sales by 20 per cent, the profit would be as under:
No. of units sold
Sales
Variable costs
Contribution
Fixed costs
:
120
:
`1,200
:
`720
:
`480
:
`300
Profit
:
`180
It would, thus, be observed that an increase in the turnover by just 20 per cent, has resulted in an increase
in profit by as much as 80 per cent.
(vii) Selling Efforts
Contribution analysis can also help the management in identifying the directions in which the selling efforts
should be augmented.
Consider the following data in regard to the two products manufactured by a concern.
Product A
Product B
Selling price
` 10
` 15
Variable costs
` 4
` 10
Contribution
` 6
`5
Fixed costs (per unit)
` 5
` 3.50
Profit
` 1
` 1.50
Profit as a percentage of selling price
10%
10%
P/V ratio
60%
33.3%
(i.e., Contribution ÷ Selling Price)
Thus, we may observe that without any contribution analysis, the tendency would usually have been to push
up the sales of product B, which gives a higher rupee profit per unit and the same percentage in relation to
turnover. However, the management will not be deceived into augmenting the sales of product B, but would
direct its efforts to sell product A much more, instead, as it generates a higher contribution percentage to cover
fixed costs. The rate at which contribution is generated by Product A (at 60 per cent) is almost twice as large
as is the case in respect of Product B (at 33.3 per cent).
(viii) Sales Incentive Plan
In the above example, consider the impact of sales incentive linked to the selling price and contribution.
Sales turnover
Contribution generated
Incentive at 1% of sales
Contribution (%)
Salesman X
Product A – 30 Units
Salesman Y
Product B – 20 Units
` 300
` 180
` 3.00
` 1.80
` 300
` 100
` 3.00
` 1.00
Thus, we see that if the objective is to generate maximum contribution, the incentive must as well be linked
to contribution, and not to the sales turnover.
CONTRIBUTION ANALYSIS AND BREAK-EVEN POINT (BEP) OR COST-VOLUME-PROFIT (CVP) ANALYSIS
465
(ix) Product Pricing Decisions
Since the variable costs of a product are directly identifiable with the specific product, and would not be incurred
without the receipt of supply order, these decisions constitute the floor price, below which no businessman
would be willing to go. The contribution analysis thus, helps in arriving at the pricing decisions and enables
the management to sell even below the ‘full costs’ (or total costs) by compensating it, with the higher volume of
sales. Consider the following data where two companies are competing for the sale of the same product:
Fixed costs
Variable costs
Full cost
Company A
4.00
6.00
10.00
Company B
2.00
8.00
10.00
The contribution would vary, depending upon the price quoted. Take the following price range:
Contribution
At selling price ` 10
At selling price ` 9
At selling price ` 8
At selling price ` 7
Company A
` 4.00
` 3.00
` 2.00
` 1.00
Company B
` 2.00
` 1.00
Nil
(Loss)
Thus, both the companies can afford to sell at ` 10 and ` 9, because the sales at these levels still generate
some contribution for each of them. However, at ` 10, the Company B must effect twice as much sale to generate
the same volume of profit as is generated by Company A. At the selling price of ` 7, Company B is priced out of
competition, in that its contribution becomes negative. If Company B accepts the order at ` 7, it will place itself
into liquidation by incurring cash losses. The higher the sales, the higher would be its quantum of losses, too.
Under the given circumstances, Company A will stand to gain some amount, at least, if the selling price is
fixed at a reasonably higher level than the variable cost, say, at ` 6.50 or ` 6.25 or so. But such a statement
may be true only when the following conditions have been fulfilled:
(a)Fixed costs have already been realized, in full, earlier; and
(b)No other product has to be manufactured by the company, and thus, the balance installed capacity of
the plant and machinery may go unutilized.
SOME OTHER USES OF CONTRIBUTION ANALYSIS
Contribution analysis helps the management in taking decisions which may lead to improvements in the profit
structure. In more specific terms, the analysis may help in answering some of the following questions:
(i)How should the product-mix change to increase the profitability?
(ii)What is the most profitable product line?
(iii)Which one of the products, in each product line, is most profitable?
(iv)How much should the sales volume increase, so as to offset the cost of additional capital expenditure?
(v)What additional volume of sales is necessary to justify the opening of a new sales office, or appointment
of an additional sales representative?
(vi)What savings in direct cost/material cost will justify buying another machine?
(vii)How should product-mix change, and/or sales increase, to offset a wage increase?
(viii)How should the products be priced for optimum profit – even below the ‘full cost’?
(ix)How much should the price be increased to compensate for the cost increase?
(x)At what additional level of sales could a given return on capital be expected?
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SUMMARY
Break-Even Point is that specific stage where income just breaks even with expenditure, i.e. where
income just equals cost. It is thus the point of ‘No Profit No Loss’.
Fixed Cost is that part of the total cost which does not vary with the fluctuations in the volume of
production, whether it is high, low, or even ‘nil’, e.g., rent and taxes, depreciation, salary and wages (as
also interest on capital, expense on research and development, advertisement, which usually fluctuate,
too, but not necessarily in proportion of the volume change).
Variable Cost, on the other hand, is that part of the cost which varies, in direct proportion to the volume
of production. For example, raw materials, consumable stores and spares, electricity charges for factory,
fuel, packing materials.
Algebraic Presentation of BEP: Q =
F
F
or Q =
S−V
C
Contribution (C) represents the selling price per unit ‘S’ (less) variable cost per unit ‘V’.
That is, S – V is also known as Contribution.
BEP could well be expressed in various ways. For example, in terms of:
(i)Volume of Production, i.e. Q =
F
F
or Q=
S−V
C
(ii)Sales Revenue, i.e. = (Number of Units) × (Selling Price per Unit)
(iii)Plant Capacity, i.e. =
100 × Current level of production
Plant Capacity
Margin of Safety: If the BEP is reached at an earlier level (say, at 30 per cent) of the installed capacity, the
additional scope of profit becomes greater (70 per cent). If the BEP is reached at much higher level (say,
at 70 per cent) the scope for profit diminishes (i.e. 30 per cent). Thus, we may fairly conclude that lower
the BEP, greater is the ‘Margin of Safety’. That is, even if the sales (and the resultant production) were
to go lower and lower, the units at lower BEP would not run the risk of incurring losses till that point.
Further, even if the production and sales were very low, the chances of the unit incurring losses will be
smaller. Reverse will be the case if the BEP were to be at higher level, in terms of plant installed capacity.
(iv)(a) Selling Price: Minimum acceptable selling price at a particular level of sales (and production), i.e.
(F + VQ)
= Price (at the BEP)
Number or Units
(b) Further, to fix the selling price so as to result in a desired net profit per year, at a given level of
production:
(F + VQ + Profit)
= Selling Price
Number or Units
But, if we cannot increase the price, due to competitive market, and we also want to retain our annual
profit at the desired level, we may increase our production and sales by applying the formula:
(F + VQ + P)
= Number of Units to be produced and sold.
Price per Units
(v)
‘Make or Buy’ decision, i.e. whether a particular component of a product, or a particular processing,
in the chain of production process, could be arranged from outside (on job-work basis) or manufactured
(in-house), by the firm itself.
(vi)
Profit projection, i.e. the quantum of profits at different levels of activity.
(vii)
Selling efforts: Without contribution analysis, the tendency would usually be to push up the sales
of the product, which gives a higher rupee profit per unit and the same percentage in relation to
CONTRIBUTION ANALYSIS AND BREAK-EVEN POINT (BEP) OR COST-VOLUME-PROFIT (CVP) ANALYSIS
467
turnover. However, the management will not be deceived into augmenting the sales of such product
but would direct efforts to sell the product, which generates higher contribution percentage to cover
the fixed costs. Thus, if the objective is to generate maximum contribution, the sales incentive must
be well linked to contribution, and not to the sales turnover.
(viii)Sales incentive plans
(ix)
Product pricing decision
As there are many variables in the study and computation of BEP, e.g. FC, VC, Selling Price, Plant
Capacity, Quantum of Profit, Volume of Sales and Production, etc., we may vary one variable and then
see the changes that take place in respect of the other variables, and watch the end-results. We may even
programme the computer suitably and get the results quickly, by varying one variable after the other.
Such a study could serve as a very valuable managerial tool for taking vital decisions in the matters of
pricing policy, launching a project, deciding about the level of production.
For some other uses of contribution analysis, please refer to page 429, Section 22.5.
REVIEW QUESTIONS
1.
(a)What do you understand by the term ‘Break-Even Point’?
(b)Explain the terms ‘Fixed Cost’ and ‘Variable Cost’ by citing some suitable illustrative examples in each
case.
2. The terms ‘Contribution’ and ‘Profit’ can well be used interchangeably. Do you agree? Give reasons for your
answer by citing suitable illustrative examples.
3. BEP can be used in many ways like in terms of:
(i)Volume of production
(ii)Sales revenue
(iii)Plant capacity
(iv)Minimum selling price
(v)Make or buy decision
(vi)Profit projection
(vii)Product pricing decision
Explain these, by citing some suitable illustrative examples in each case.
4. What do you understand by the term ‘Margin of safety’? Explain, by citing some suitable illustrative examples.
5. Contribution analysis helps the management in taking a decision regarding enhancing the selling efforts of the
product say, X or Y? Do you agree? Support your specific view, by citing some suitable illustrative examples.
6. What types of problems/questions could be solved with the help of the Cost-Volume-Profit analysis?
7. What types of assumptions are made in regard to the Cost-Volume-Profit analysis?
8. Write down the formula used in the computation of:
(i)Break-even Quantity, and
(ii)Break-even Sales, in terms of rupees?
9. There are various limitations pertaining to the Cost-Volume-Profit (or Break-Even) analysis? Please discuss.
10. It hardly makes any prudent business sense to operate at the Break-Even Point’. Thus, the BEP analysis can
hardly serve any useful purpose in terms of any managerial decision. Do you agree? Give reasons for your
answer.
11. An international pharmaceutical company is selling its Product ‘A’ in India at a price of ` 100 per unit. It
has now received an order for the supply of 100 million units of this product from the Government of France.
But the price offered is just ` 20 per unit. The variable cost of the product, however, is ` 15 per unit, and the
fixed cost (though fully realized over the years by now) stands at hefty ` 100 million. The company is already
operating at 70 per cent of its installed capacity, whereby it is meeting all the current demands for the product
as of today. Should the company accept the offer, or decline it on the ground of a terribly low price? Give specific
and convincing recommendations to the company.
468
FINANCIAL MANAGEMENT: THEORY AND PRACTICE
PRACTISE PROBLEMS
1. A company engaged in the manufacture of soft toys sells these at ` 30 per unit. The Variable Cost per unit
comes to ` 18 and the Fixed Cost is computed at ` 15,000. Calculate the BEP in terms of:
(i)Number of units to be sold, and
(ii)Total value of sales
2. A company manufactures 12,000 units of pens, all of which get sold off fast enough at the selling price of ` 50
per unit.
The variable cost per unit is ` 30. Profit Before Interest and Tax (PBIT) is ` 40,000. Calculate the Fixed Cost.
3. Sunshine Instruments sells hospital equipments at a per unit price of ` 1,500 and its variable cost is ` 900.
The fixed cost is ` 3 lakh.
(i)Compute the Break-even Point (BEP) in terms of:
(a)Number of units to be sold, and
(b)Sales volume in terms of rupees.
(ii)What will be the BEP if the selling price goes down to ` 1,400 per unit, instead, presuming that there is
no change in the fixed cost?
(iii)What will be the BEP if the fixed cost goes down to ` 1,00,000, if the company would have planned to go
in for hand-operated machines, instead of the fully automatic ones?
4. Compute the Break-even Point (BEP) in terms of both the value and volumes of sales (that is, in terms of both
the number of units sold, and the total sales revenue generated), with the following data:
Selling price per unit
Variable Cost
Fixed Cost
`150
`90
`50,000
5. What will be the minimum acceptable price at which the company can afford to sell its specific product, under
the following circumstances:
Variable Cost
`10
Fixed Cost
`50,000
Level of production and sales, in terms of units, being different, given as follows:
(i)20,000
(ii)18,000
(iii)15,000
(iv)12,000
(v)10,000
6. The installed capacity of the plant of Aditya Chemicals is 50,000 units per year.
The other available data are as follows:
Fixed Cost
Selling Price
Variable Cost
=` 60,000 per year
=` 20 per unit
=` 14 per unit
Calculate the BEP in terms of installed capacity.
7. The relevant figures of the two companies A and B, are given as follows:
Company A
Company B
Total installed capacity
2,00,000
1,20,000
Break-even sales
1,00,000
1,00,000
(i)Calculate the Break-even point reached in terms of per cent (%) capacity, as also the margin of safety.
(ii)Which of the two companies, in your opinion, may be said to be better placed, in the competitive market
in India, which is known to be very cost-conscious?
Give convincing reasons for your specific answer.