Break Even Analysis: Analysis In Finance Management

Break even analysis:

Break even analysis is a very interesting technique which helps a finance manager to know how many units should be produced and sold at a minimum cost without losing money. So this activity is called as break even analysis. The break-even point is the minimum quantity at which loss is avoided.

Example:

A company is setting up its new project in Bangalore. The below given information is the projections of the project.

Cash flow forecast for new project Year – 0 (Rs) Year 1-10 (Rs)

Investment (60,000)

Sales 54,000

Variable Cost (60% of sales) 32,400

Fixed costs 3,150

Depreciation 5,850

PBT 12,600

Tax @ 35% 4,410

PAT 8,190

Cash flow from operation 14,040

The variable cost of sales is 60% that is 0.60 ( 32.4/54) . This shows that every rupee of sales makes a contribution of Rs. 0.4 .

The break even level of sales = (Fixed cost

The model will have a set of equations for each variable .These equations help to estimate the expected value and forecast errors during the life of the project. For example Consider Revenue as a function of market price, market share and unit price.

2 A probability distribution is specified for every variable in the model: The historical data helps to estimate the probabilities. This helps to incorporate all the errors and to forecast the data.

3 Cash flow simulation: This step generates the cash flow for every year with the single outcome. The computer gives a single outcome at the end of the period.

4 The Step 3 procedure has to be repeated: The cash flow is distributed with the help of a computer by generating millions of outcomes each year. Simulation analysis helps to distribute cash flows from various