Abstract Break even analysis is a method that has been applied by many business operations in determining the least operational points which they can operate and still remain in business. It is very important for a business that has just entered the market and wants to win its market share before it can set the selling prices for its prices. It is also applicable in events where here are a number of competitors a firm wants to win. Break even point is defined as the point below which a business cannot operate. At this point, the business should be able to cover all its costs, which are fixed and variable costs.
It is measured in either product units or dollars. Bill French, Accountant The break even analysis is a very important tool to help any firm in deciding on the best operational volume. It requires three types of costs namely the fixed cost, variable cost and selling price (Dayananda, et al, 2002). As Bill French puts it, “the level of operation at which total costs that is, variable plus non-variable are just covered is the break even volume” and it is the least volume that an organization should operate in order to remain in business (Harvard Business School, 1987).
There are several assumptions that are made in order to calculate the break even figures since with all the factors considered, it is very hard to compute the figures. In determining the break even figures for the firm, French makes some implicit assumptions. Most of these assumptions are evident in the conversation he is having with the participants at the meeting. In his calculations, Mr. French does not give room for the excepted sales volume increase which according to Cooper, one of the participants from the production department, will increase sales by 20%.
He further assumes that the plant capacity is only at 90% utilization implying that it is not fully utilized. However, we learn from Williams (who is from the manufacturing department) that the plant capacity may be at 100% as he argues that in some of the sectors, there is no room for further expansion. Mr. French does not consider the three products produced by this firm individually but rather on averages proving that it will not be easy to calculate break even figures for each of the products individually.
In fact, French argues “that there is only one break even point for the firm” and thus it is the only point to be hit whether considering each product individually or in group (Harvard Business School, 1987). It is evident that the method used by French to calculate for the break even analysis does not allow for change in the product mix since he assumes that nothing will be altered. For instance, the price of product C is very low and therefore need to be included in the analysis that there are products which may change in prices but this is not the case with French.
Bill has also assumed expected union demands, taxes and dividends. With French revising his method of calculating the break even analysis, he will have to consider some other increase and decrease in costs. This will make the break even figures change to 2,000,000 units as the aggregate figure. The sales volume is 400,000 units for product A, 400,-000 for product B and 950,000 for product C. The unit sales will be $6. 948 as the aggregate, $10 for A, $9 for B and $4. 8 for C.
In order to pay the extra dividend of $25,000, the firm has to increase the sales volume as follows; the price per unit remains at $1. 2, variable cost at $0. 75 while fixed costs increase to $(520,000 +25,000) =$545,000. The units to cover for this; 1. 2x=0. 75x+$545,000= $545,000/0. 45x; x=1,211,111 units. In order to meet the union demands of 10% increase in production costs, it follows that the total variable costs will have to increase by 10% since production costs are in the variable costs category. The calculation of the break even units will be; 1. x=0. 75x+0. 1x+$525,000= $525,000/0. 35x; x=1,500,000 units. In order to meet the union demands and pay for the extra dividends, the break even point will be; 1. 2x=0. 75x+0. 1x+$525,000+$25,000= $545,000/0. 35x; x=1,557,142 units. With the break even analysis, the firm will easily make a decision on whether to alter the existing products. It is true with the alterations, the sales volume has to increase and if the firm finds that it is not possible to make the extra sales, it will have to stop with the alterations.
For instance, it is planned that there is extra investment on the C product which will mean an increase in costs. Since the firm’s capacity is thought to be at the maximum, it will not be possible to make the increased investment. Break-even analysis is very useful tool in all business operations. Although it has the disadvantages brought about by the assumptions made, it has its own advantages as well. The disadvantages are the assumptions that everything produced is sold and at the same price.
However, the advantages which make it useful and each of the firm is advised to use it are that it is cheap and it helps a firm acquire a loan. With its relationship of returns, volume, production and cost shown, the firm will be able to make decisions on whether to take some business ventures or to leave them (Accountingformanagement. com, 2009). With the use of a break even analysis, it is very easy to determine whether a firm is on the best track of doing business without making profits or losses. References Accountingformanagement. om. (2009). Break Even Point Analysis-Definition, Explanation Formula and Calculation. Retrieved from http://www. accountingformanagement. com/Break_even_analysis. htm#Benefits%20/%20Advantages%20of%20Break%20Even%20Analysis Dayananda, D. , Irons, R. , Harrison, S. , Herbohn, J. & Rowland, P. (2002). Capital Budgeting: Financial appraisal of investment projects. Cambridge: Cambridge University Press. Harvard Business School. (1987). Accounting: Bill French, Accountant. Retrieved from http://www. hbsp. haravard. edu.