Break Even Analysis

What is the formula to calculate the margin of safety percentage?

Actual sales volume minus break-even volume _______________________________________________ actual sales volume

What is the cost volume profit analysis or break-even analysis?

Cost-volume-profit analysis or break-even analysis is a tool used to indicate the possible impact alternative courses of action will make on profits.

Definition of Fixed costs.

Fixed costs remain constant over a relevant range of activity. Production capacity is reflected in fixed cost items such as depreciation on plant and machinery, rent/lease of the factory.

Definition of semi-variable costs/ mixed costs

Few costs are strictly fixed or variable. Some per unit variable costs will increase at different output levels. Costs like electricity and telephone have a fixed line charge and a variable use charge. These are called mixed costs.

Definition of margin of safety.

Once break-even has been established, a margin of safety at the current or desired level of production can also be calculated. The margin of safety calculation shows the percentage drop in sales volume which will result in the firm being at break-even.

Definition of relevant range.

Relevant range refers to the range of output possible given the firm's current resources. If production is extended beyond the relevant range of output, additional investment will be required in plant, factory etc and this would increase fixed costs.

Definition of contribution margin.

The amount left from each sale after variable costs have been accounted for. This amount is then available to contribute to fixed costs and profit. If the contribution margin just covers fixed costs the business is at break-even. No profit is made. The contribution margin can be used in a number of ways to calculate breakeven (and other levels of) sales units and dollars.

Definition of variable costs.

Variable costs change in proportion to a change in volume or output. Direct product costs and marketing expenses are examples of variable costs. We assume that variable costs per unit are constant over the relevant range.