Managerial Uses of Break-even Analysis To the management, the utility of break-even analysis lies in the factthat it presents a picture of the profit structure of a business firm. Break-even analysis not only highlights the areas of economic strength and weaknesses in the firm but also sharpens the focus on certain leverages which can be operated upon to enhance its profitability. Through break-even analysis, it is possible for the management to e amine the profit structure of a business firm to the possible changes in business conditions. !or e ample, sales prospects, changes in "ost structure, etc. Through break-even analysis, it is possible to use managerial actions to maintain and enhance profitability of the firm. The break-even analysis can be used for the following purposes# $% &afety margin '% (olume needed to attain target profit )% "hange in price *% + pansion of capacity ,% +ffect of alternative prices -% .rop or add decision /% Make or buy decision 0% "hoosing promotion-mi 1% +2uipment selection $3% 4mproving profit performance $$% 5roduction planning S a f et y M a r g i n The break-even chart helps the management to know the profits generated at the various levels of sales. But while deciding the volume at which firm would consider the safety the operate, apart from the demand, the management should margin associated with the proposed volume. The safety margin refers to the e tent to which the firm can afford a decline in sales before it starts occurring losses. The given a reduction in price. This means that the volume of sales will have to be increased to maintain the previous level of profit. it becomes much easier for -the management to =udge whether the re2uired increase it sales will be feasible or not. the higher will be the increase in sales needed to maintain the previous level of profit. The formula for target sales volume is# Target &ales (olume 8 Chang e i n Pric e The management is also faced with a problem whether to reduce the prices or not. . But the information the elasticity of about elasticity of demand may not be <n the !i ed costs : Target profit "ontribution margin per unit easily available. which is affected b y demand.(" where >n 8 ?ew volume of sales !" 8 !i ed cost 5 8 5rofit &5n 8 ?ew selling price (" 8 (ariable cost per unit 6n denotes new% C h a ng e i n C os t s >n 8 !" : 5 . would be as under# &5n . necessary to achieve a target profit. A reduction in price results in a reduction in the contribution margin as well. reduction in prices may not always lead to an e2ual increase in the sales volume. The management will have to consider a number of points before taking a decision related to the change in the prices. Break-even analysis helps the management to know the re2uired sales volume to maintain the previous level of profit. basis of this knowledge and e perience. The higher the reduction in the contribution margin.formula to determine the safety margin is# 6&ales 7 B+5% &afety Margin 8 &ales $33 V o l u me N e e d ed t o A t t a i n T a r g e t P r o f i t Break-even analysis is also utili9ed for determining the volume of sales. The formula to determine the new sales volume to maintain the same level of profit.owever. the affect is to raise the break-even point of the firm. which are e plained as follows. given a change in fi ed costs. !"n 7 &5n 8 &5 : !" > . !"n 7 >n8 > : !" &5 (" '. 4n such a situation. A firm also determines the price lhut should be set to maintain the present level of profit without any change in sales volume.(" n '. would be# $. given a change in variable costs. 4n both the cases. while keeping the prices unchanged. are# $. The new 2uantity will be# !" :5 >n 8 &5 . The new selling price will be# &5n 8 &5 : 6("n("% "hange in fi ed cost# An increase in fi ed costs of a firm is caused either by e ternal circumstances such property ta es or by as an increase in a managerial decision such as an increase in e ecutive salaries. The formulae to determine the new 2uantity or the new selling price.Break-even analysis@ helps to analyse the changes in variable cost and fi ed cost. The same determination is undertaken by the firm regarding the sales volume while keeping the profit level same as before. The formulae to determine the new 2uantity or the new price. a firm determines the total sales volume needed to maintain the prescnt profits withcut any increase in price. "hange in variable cost# An increase in variable costs leads to a reduction in the contribution margin. relies while choosing their largely upon e perience and =udgement. But it is not necessary that the profit potential at higher prices may actually be achieved by the firm. through the installation e2uipment. Though even analysis. * per unit with a demand at /. The E f f e c t o f A l t e r n a t i v e P r i c es The break-even chart can be modified to show the profit position at different price levels under assumed conditions of demand and costs. The following !igure . Drop or Add Deci si on An economist takes the decisions regarding the following# Addition of a new product keeping in consideration..E xp ansi on of Capaci ty The management may also be interested in knowing whether to e pand of this production capacity or not.shows the effect of B+5 in alternative prices. !igure . with a demand at *. . As can be seen from the figure.333 units. a trial price.. the break-even point becomes lower as the price increases. 4t is not desirable for a firm to take every price into consideration. . shows the profit position at alternative prices for the firm in e ample $. its cslimated revenue and cost.. The analyst. . it would be possible to e amine the various applications proposal or installation of the following e ample illustrates the points involved. A price of As. its conse2uent effects on revenue and cost.eletion of a product from the product-line keeping in consideration..333 units will give a higher profit than a price of As. additional e2uipment. "ustomary price is one such price. depending upon the most economical one. etc. such as personal selling. a choice is to be made in between three or more methods. say. a manufacturer may have to decide if he should spend an additional sum of As.Break-even analysis is also useful in taking decisions related to product planning. . which are as follows# 4ncreasing the volume of sales 4ncreasing the se4ling price Aeducing the variable e penses per unit Aeducing the fi ed cost Prod ucti o n pl anni ng Break-even analysis can also help in production is planning so as to give ma imum contribution towards profit and fi ed costs. &ometimes. '3. But when bigger 2uantities are to be produced. advertising. Ma e or !uy Decisio n Many business firms may opt to produce certain from outside suppliers. !or instance. or purchasing them manufacturer can make spark plugs or buy them. A retail shop may have to consider whether or not to employ a certain number. Break-even analysis enables him to take appropriate decisions by showing how the additional fi ed costs influence the break-even points. use of simple machines. But the proportion of all these methods in the promotion mi varies from seller to seller. $mproving Profit Performance There are four specific ways in which profit performance of a business can be improved. !or instance. this can be easily understood# Cho osi ng Pr omoti on"mi x &ellers often use several methods of sales promotion. faster but usually costlier machines are to be employed. which are part of their finished products. is usually best for small 2uantities. Bith the help of following e ample. components or an automobile ingredients. E # uip ment S el ecti on Break-even analysis can also be used to compare different ways o6doing =obs.333 on advertising his product or not. Break-even analysis can enable the manufacturer to decide whether to make or buy. &imilarly. five additional salesmen.