Qusetion 1 - question and answer on break even analysis PDF

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question and answer on break even analysis...

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1. Undeniably, breaking even is not the ultimate goal of firms. Why then bother about break-even analysis? The aim of every firm is to make profit and maximize shareholders wealth. Although accountants are prudent and always anticipate for losses, no accountant wants to make losses but at worst break-even. To the economist, a firm can make super-normal profit, normal profit or abnormal losses. It is this view of the economist that management accountants will settle for breaking even rather than recording losses as break-even is seen as normal profit. Break- even is the recording of zero profit thus no loss nor profit. At break-even, revenue is equal to expenses (cost). The break-even point is the point at which revenue generated is only enough and sufficient to defray all cost incidental to the generation of revenue. Although breaking even is not the ultimate goal of firms, the following are some of the reasons why a firm will like to break-even. To start with, a new firm that just entered the market will appreciate breaking even if the firm cannot make profit. This is because the initial set up cost which is more likely to be fixed may be high in the prime years of operation. To an existing firm, in times of general economic hardship, a firm will budget to breakeven to still be in business. At break-even both fixed and variable cost have been paid. Generally, fixed cost will also be incurred as a business continues to be in operation. In the short term, a firm cannot control fixed cost ceteris paribus, therefore the firm will budget to operate at a level where all fixed cost in addition to variable cost can be paid.

Break-even analysis is a management tool used to evaluate business performance in terms of cost, revenue and profit. In some jurisdiction, Break-even analysis is also known as Cost-Volume-Profit analysis as this analysis concentrates on budgeting for the number of units that must be produced and sold to make profit. It helps management plan and know the number of units to sell and at what price in order to be able to pay all costs whether variable or fixed. This analysis helps determine the break-even point. In addition, Break even analysis helps determine the selling price and units necessary to achieve a target profit. With a target profit budgeted for, and all relevant cost information about a product gathered, a good break-even analysis conducted by management will help determine the selling price per unit necessary to achieve the targeted profit for the period holding all other factors such as units of production constant. Where the selling price per unit needed to achieve the target profit is expensive relative to that of the average price of the product on the market, number of units necessary to achieve the target profit must be determined whilst management look for alternative and cheaper ways of producing the product. Hence break-even analysis can be used as a cost control tool. Break-even analysis helps determine the contribution margin. The contribution margin shows how much of the company’s revenue contributes towards the recovery of fixed cost. Since contribution margin is ascertained by subtracting all variable cost from revenue, management will be able to determine how much of revenue is spent on fixed cost. Although total fixed cost is fixed for a period, per unit fixed cost tends to have an indirect relationship with quantity of units produced. Conducting break-even analysis will

help management plan the number of units to be produced in order to reduce the contribution margin per unit. Break even analysis helps to anticipate for and reduce loss. During break- even analysis, management is able to determine the level of margin of Safety at which the company must operate in periods of economic crisis. The margin of safety is the level of output above the break-even point. It provides a measure of output range within which profit or losses will be made. It serves as a test of how safe the firm is in terms of shipping into losses and the activity level at which the firm will make losses is ascertained. Undeniably, break- even is not the ultimate goal of firms as firms want to survive, make profit and grow in order to maximize shareholders wealth whilst creating value. However, a good break-even analysis helps management achieve their goal for a period and reduces losses to be incurred as breakeven analysis is both a planning and control tool....