The break-even analysis is a simple tool employed to graphically represent accounting data.
Advantages And Limitations
Of Break-Even Analysis
The break-even analysis is a
simple tool employed to graphically represent accounting data. The data
revealed by financial statements and reports are difficult to understand and
interpret. But when the same are presented through break-even charts, it
becomes easy to understand them. Break-even charts help in:
Determining total cost, variable
cost and fixed cost at a given level of activity.
out break-even output or sales.
the cost, volume, profit relationship.
the best product mix.
On the negative side, break-even analysis suffers
from the following limitations:
1.It is very difficult if not
impossible to segregate costs into fixed and variable components. Further,
fixed costs do not always remain constant. They have a tendency to rise to some
extent after production reaches a certain level. Likewise, variable costs do
not always vary proportionately. Another false assumption is regarding the
sales revenue, which does not always change proportionately. As we all know
selling prices are often lowered down with increased production in an attempt
to boost up sales revenue. The break even analysis also does not take into
account the changes in the stock position (it is assumed, erroneously though,
that stock changes do not affect the income) and the conditions of growth and
expansion in an organisation.
2.The application of break-even
analysis to a multiproduct firm is very difficult. A lot of complicated
calculations are involved.
3.The break-even point has only
limited importance. At best it would help management to indulge in cost
reduction in times of dull business. Normally, it is not the objective of
business to break-even, because no business is carried on in order to
break-even. Further the term bep indicates precision or mathematical accuracy of
the point. However, in actual practice, the precise break-even volume cannot be
determined and it can only be in the nature of a rough estimate. Therefore,
critics have pointed out that the term `break-even area’ should be used in
place of bep.
4.Break-even analysis is a
short-run concept, and it has a limited application in the long range planning.
Despite these limitations, break-even analysis has
some practical utility in that it helps management in profit planning.
According to wheldon, `if the limitations are accepted, and the chart is considered
as being an instantaneous photograph of the present position and possible
trends, there are some very important conclusions to be drawn from such a chart’.
Tags : Accounting For Managers - Management Accounting-Cost Volume Profit Analysis
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