introduction to break-even analysis
Introduction Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production). Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point"). The Break-Even Chart In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:
In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made. Fixed Costs Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.
Examples of fixed costs: - Rent and rates - Depreciation - Research and development - Marketing costs (non- revenue related) - Administration costs Variable Costs Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenuerelated costs such as commission. A distinction is often made between "Direct" variable costs and "Indirect" variable costs. Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples. Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs. Semi-Variable Costs Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.
DMRC poised to break even in 2 years
The environmental and social benefits from the Delhi metro will help it recover the entire cost two years earlier than anticipated Sadiq Naqvi Delhi Hardnews
The Delhi Metro Rail Corporation (DMRC) is set to recover the entire cost of Phase I by 2011. This was estimated in a study conducted by the Central Road Research Institute (CRRI).
According to a recent report by the CRRI, the environmental and social benefits due to this mass transport system will help recover the cost two years earlier than what the CRRI had anticipated earlier in a previous report. As per the new study, the break-even point for the phase I cost will be achieved by 2011.
This, according to the CRRI, is due to the increasing popularity of the metro as the preferred mode of transport in Delhi. In 2007, 5,00,345 travelled everyday by the metro. The figure has increased to 8,50,170 in 2009. This has also increased the economic rate of return (ERR) which went up from 16.90 per cent to 19.98 per cent from 2007 to 2009. However, ERR should not be confused with the financial rate of return as it takes into account the effect of factors such as price controls, subsidies and tax breaks to compute the actual cost of the project to the economy.
The study points out that if the social and economic benefits are quantified then the value of accrued benefits of Phase-I by March 2012 will become Rs 10,801.64 crore as against Rs 10,571 crore which was the cost incurred in the construction of Phase I. These benefits are a result of passenger time saved, fuel cost saved, reduction in capital and operating cost of vehicles, reduction in environmental damage, accidents prevented, time saving and low maintenance cost of infrastructure.
According to the study, the metro is helping the environment in a big way as it will prevent emission of 1,31,395.34 tonnes of greenhouse gases upto 2009.
The other main highlights of the latest CRRI study are: Saving in travel time: The annual cost saved by metro passengers on account of reduced travel time will go up three times from Rs 310.13 crore in 2007 to Rs 947.07 crore in 2009. Fuel cost saving of metro passengers: The annual saving on account of reduced fuel consumption will be Rs 180.89 crore in 2009. Number of vehicles off the road: In 2009, the Metro will take the daily share of 57,953 vehicles for all other modes of travel such as cars, buses, two-wheelers, auto-rickshaws, etc. Vehicle cost saving: The annual vehicle (capital and operating) cost saving will almost triple from Rs 93.21 crore in 2007 to Rs 276.24 crore this year. Emission cost saving: The emission cost saving will also increase almost three times from Rs 14.29 crore in 2007 to Rs 41.04 crore in 2009. Number of accidents avoided: The metro will help avoid a total of 255 accidents, including 51 fatalities, in 2009. In 2007, the respective figures were 196 and 21. Accident cost saving: The accident cost saving will be Rs 9.35 crore this year as against Rs 6.28 crore two years ago. Improvement in road journey: The annual cost saved by passengers traveling by road on account of reduced travel time will be Rs 240.18 crore in 2009.