Limitations of Break Even

Limitations of Break Even

Limitations of break even analyses can be explained in term single product analyses, fixed cost assumption, unit sale price and variable cost assumptions. Limitations of break even analyses have been explained below

1.    Single Product Analyses

First limitation of break even analyses is its limited scope.  Break even analyses is a single product analyses. It holds well for a single product, it does not work even for two products. Therefore in modern business, where most industries are involved in producing more than one product, break even analyses cannot be used.

2.    Fixed Cost is not always fixed

Break even analyses assumes that fixed cost will remain fixed for all time, which is not the real world scenario. In practical business environment fixed cost remains unchanged up to certain limits, and then it take an upward jump. For example factory storage is not sufficient for all level of material; similarly more supervision is required for increased production level.

3.    Sale Price is not Constant

Break even another limitation is its wrong assumption of constant unit sale price. In practical business, it is not possible to keep the sale price constant. Demand rule says that for increased demand (sales), you need to decrease the price. Sales price is a changing phenomenon that is not recognized in break even analyses.

4.    Unit variable cost is not Constant

Break even analyses other important limitation is its assumption of constant unit variable cost . Again variable cost cannot be kept constant at all level. In increased production level it tends to fall due to economies of scale and in extreme production, it will rise again. (More supervision is required).


Limitation of Break even analyses are listed below

• It is a single product analyses.
• Its constant unit sales price assumption is not valid.
• Its constant variable price assumption is not correct in real business world.
• Its constant fixed cost assumption is also not valid.

Advantages of Break Even

Advantages of Break Even

1.    Simple

Break even is based on the simple mathematical formula. it is very easy to calculate & understand the calculation. Break even does not involve any complex mathematical or financial calculation.

2.    Basic Decision tool

Break even analyses provides one of the key fundamental information i.e. no profit no loss situation. Many businesses especially in case of new investment are interested in this information. Every business take time to provide desired return, therefore management is interested to cover its costs in early stage.

3.    Link between Volume & Profitability

Break even defines the link or association between volume and profitability. You can improve profitability, by increasing the volume of sales. Break even analyses explains very well that fixed cost can be covered only by increasing contribution.

4.    Widely Used in low stock industry

Break even is widely used in industry, where there is low stock, (produced goods are sold). Break even analyses is used as basic decision making tools by the management.

5.    Desired Profitability

Break even formula with slight change i.e. (adding profit amount to fixed cost) can also be used to determine the desired profitability volume level.

6.    Setting Price

Break even analyses explains that setting of price is very importance, because it has direct link with contribution and profitability.

7.    Variable Cost Role

Break even analyses also explains the role of variable cost in the profitability, it explains that contribution can also be increase by lowering the variable cost. It also explains that variable cost is more relevant for decision making than fixed cost.

Break Even Characteristics

Break Even Characteristics

Break even is point, where organization operates at no profit any loss. It means that it is a point, where organization covers its fixed costs. There are two basic assumption break even analyses i.e. fixed cost does not change, sale and unit variable price does not change.

1.    Fixed Cost is same

2.    Unit Variable cost will remain same

3.    Unit sale price will remain same

Break Even Formula

Fixed Cost/ unit contribution

Where;

Unit contribution = unit Sale price – Unit Variable Cost

Break Even Formula Example

Sale Price = 40

Variable Cost = 20

Fixed Cost = 80,000

What is break even point?

Solution

Unit contribution = 40-20

Unit contribution = 20

Required level     = Fixed Cost/unit Contribution

 =80,000/20

 =4,000 units

Break Even Formula

Break Even Formula

Break even is a point, where organization is earning neither profit nor incurring any losses. This concept has fundamental importance for decision making. Break even point may be calculated by the following formula

Fixed Cost/ unit contribution

Where;

Unit contribution = unit Sale price – Unit Variable Cost

Example

Unit Sale Price = 60

Unit Variable Cost = 50

Fixed Cost = 50,000

What is break even point?

Solution

Unit contribution = 60-50

Unit contribution = 10

Required level     = Fixed Cost/unit Contribution

 =50,000/10

 =5,000 units