Application of Break Even Analysis
Application of Break Even Analysis
Application of Break Even Analysis
5) The break-even analysis helps to determine whether an expansion of capacity is desirable or not. When a firm expands, its fixed cost rises. With it, the level of output and variable cost also increase. The break-even output also increase. To maintain the current rate of profit, sales are to be raised. So, before taking any decision on expansion of capacity, the firm will have to examine how these variables change. All these can be known from the CVP analysis. 6) The CVP analysis can also be utilized to know whether it is profitable to add a new product or to drop an existing product. The firm will have to see whether profit rises or not if a new product is produced instead of an old product. This can be seen from the CVP analysis. 7) Most often a firm has to decide whether certain inputs should be produced by itself or bought from outside. The CVP analysis helps to take decision in this case also. 8) The break-even analysis can also be utilized to determine the degree of operating leverage of the firm. The degree of operating leverage is defined as:-
The answer in this case is 154 buses, which is the target number, the expected volume that covers both fixed and variable rental expenses of this new project. The management of Advertising Ltd. considered that pre-start projections and operating realities may be different and that the company may fall below the break-even volume. Generally, there are three ways for a company to lower its break-even volume, two of them involve cost controls: Lower direct costs (controlling inventory), which will raise the gross margin, exercise cost controls on fixed expense (use of capital budgeting) and raise prices (not easy in a price-sensitive market).
Conclusion
Break-even analysis is useful as a first step in developing financial applications, which can be used in invoicing and budgeting. The main purpose of this analysis is to have some idea of how much to sell, before a profit will be made. Break-even analysis is extremely important before starting a new business because it gives answers to crucial questions such as how sensitive is the profit of the business to decreases in sales or increases in costs. This analysis can be also extended to early stage business in order to determine how accurate the first predictions were and monitor whether the firm is on the right path or not. Even, mature business must take into consideration their current B.E.P. and find ways to lower that benchmark in order to increase profits.