Effective Application of Breakeven Analysis in Managements Firms

EFFECTIVE APPLICATION OF BREAKEVEN ANALYSIS IN MANAGEMENTS FIRMS

DEFINITION

Not only does it furnish management with the general information on the cost –volume- profit relationship of the firm accountants can also use breakeven analysis to finance management with information necessary for solving certain planning control and special  decision problems however the decision areas where this is applicable includes profit planning, budgeting control production replacement pricing decision, selection of distribution channels, setting volume sensitive returns on investment target entry into foreign market etc.

PROFIT PLANNING

In the short term operating level profit planning essential deals with how volume output, cost of production and sales prices and revenue from sales and profit sale are related to each other and how any action which effects any are of them will probably change the remainder profit planning to level itself readily to breakeven analysis.

Applying breakeven analysis have involves conduct the basic breakeven analysis using a forecast or planned economic structure of the firm as a data sources and the examining how planned profit will change if fixed cost; variable cost, selling price and sales volume are varied. This type of analysis will enable the management know if the existing structure of the firm on which the basic analysis was conducted is the optimal structure and if not to know in what  direction changes are required. In a breakeven analysis for profit planning it is used to come across charts.

MAKE OR BUY DECISIONS

Manufacturing firms sometimes faced with make or but decisions problems. This form of problems wises when a firm has the alternative of manufacturing over or more if the components or part if which it uses. Within the factoring or purchasing it (Them) from external supplies. The producer when using breakeven analysis to solving this problem consists of calculation of cost of buying calculation of the cost of making (which is no idle capacity  situation may include cost of acquiring additional capacity to make and/or host contribution from displaced production) and the calculation of the breakeven point for “make” if the breakeven point for “Make” to lower than the component required the firm should “Make” but if it is higher, the decision should be a buy.

EQUIPMENT SELECTION AND REPLACEMENT

Breakeven analysis could not be used in the areas of equipment selection and replacement what in essentially in involved in  the analysis herein the  comprise of the different total effective machine within the  relevant activity range incidentally on this companies are “different points” which are activity level where the total cost of running either of two alternative machines are equal

For example:  Chimex plastic (ND) Ltd, contemplates replacing its old machine with a new one. The old machine have a zero book value having been fully deprecated but can still be used for production purposes at a variable cost per unit of production of N2 of the new machine to replace the old one the firm had to choose between alternative B and C. B will add N 3 a year to the firms cost and has a per unit variable cost of N 1 C will add N 9,000 to the firms fixed cost of purchase. But it has unit variable cost of 60k it is estimated that machine B and C will not fall below N 14,000 units. Here the management of chimex plastic ltd in faced with the decision problem of which machine to use (or purchases to use).

To supply management with information needed to waive at a decision, we have to start by staring the total cost function for the 3 machines.

Let the old machine be machine A

TC (A)        =       N 0 + N 20           …………………………Machine A

TC (B)        =       N 3,000 + N 19    ………………………….Machine B

TC (C)        =       N 9,000 + N 0.509         ………………………….Machine C

Where TC   =       Total cost

9        =       Activity level in units

MANUFACTURING FIRMS

A manufacturing vim is  business units engaged in manufacturing. Manufacturing has been defined by A.E. Bemms as: Organization of human and physical agencies of production and utilization of modern machinery along with the principles of division of labour, specialization, standardization and principles of producing usable products. Manufacturing has also been defines as change the raw materials into finished goods by some chemical or mechanical process the first definition tried to present the complex nature of manufacturing process while the second points out outputs are dirigible.

 MANUFACTURING SYSTEMS

In a market, manufacturing firms usually have profit making as their primary motive and objective. To be able to achieve this objective manufacturing firms usually design their operations along efficient and “Utility creating” lines. The designing is done so that a particular firm adopts a system of production that suits best its operation.

System of production which are sometimes, restrictively  manufacturing system are method of organizing. Manufacturing process so that the right quality of goods are produced at the need quality, right time an reasonable cost. Three forms of manufacturing system are obtainable;

  • Mass production
  • Ymgue – product production
  • Process production (Hano Johnson and G. Yerry 1981).

 MASS PRODUCTION

Mass production in defined by Derek French and Hearther seward as: Production (usually machinery) of large quantity of something either a repeated undifferentiated production or a repeated basic structure with minor individuals (e.g in colour or accessions).

Thus in a mass production system, large qualities of uniform and/or near uniform production are turned out Drucher, in one of his books, differential between rigid and flexible mass production. He described the rigid type as a mass production system where the products, tools materials and parts are standardized and uniform while the flexible type refers to a situation of standardized part with diversified products.

In a firm operating mass production system , application of breakeven analysis is quite easy. In rigid mass production situation, it is a simple one product analysis while a flexible mass production situation, sales mix analysis will have to be conducted .

This is a manufacturing system where production are made to a particular specification (Lymann A Keither and carlo .E. Gubellin, Op Cit, P.254) it is also known as job-order or which are different entities on their own. Work can be stopped after any stage without harm being done to the semi-finished  products. Tools in a custom production system are usually standardized and firms operating it need general purpose equipment that can do varied jobs breakeven point of firms using this system is usually low because on every order there is the at tempt by management to make profit.

PROCESS PRODUCTION

This manufacturing system describes an integrated production situation where the production can be produced only by a carefully controlled square of operations in which there are usually capital intensive with plant being designed, as Hano Jolurannson G. Terry puts it, to fit the technological  requirements of the process rather than needing to accommodate large number of successive worker operation. The system produces only those products for which if has been designed for example a petroleum refinery where the products that could be forgotten from the crude oil depends on the cradling lower which was built into refinery’s integrated system. Breakeven analysis for this system could be easy because where there are different product the accountant can readily know the production of each product from the system design.

USE AND APPLICATION OF BREAKEVEN ANALYSIS

          Breakeven analysis has been described by C.J. walker as “An invaluable management tool”. This description of  the analysis is highly held when its use in the area of short-term profit planning in discussed; pointers to this about in literature Glanster and under down noted that. Cost planning is important” And pandy  added that “Breakeven analysis in that breakeven analysis make it possible for management to study” analyzed relationship of cost, selling price, product mix and volume of output applied to products process, sales etc, instead of ordinarily and in some cases misleading total overall relationships.

Product planning and make-or-by decision could be said to be in the exclusive  domain of breakeven analysis. With respect to product planning, one best way of tackling its problem is through relevant costing margin (P/N) ratio (Charles T. Horagren, 1984) when discussing make or buy decisions. Decoster and Schaffer said “The economic effects of incremental income. The above motioned are just pointers to the central position occupied by breakeven concept in decision making for these decision areas.

In evaluating the use of breakeven analysis in budgetary control burdear wrote. Although the adequate budget program can be developed without using cost-volume – profit techniques, these techniques can add to the understanding and usefulness of budget procedures and forecasts.

We can therefore see that in budgeting control, breakeven analysis could  be used as complementary technique. When used it will enable decision managers appreciate why the budget exists and needs to be attained providing information on the firms breakeven point margin of safety are volume that needs to be achieved in order to meet any planned dividend payout the relations effect of this information in reducing middle managements conception of budgeting described by C.T Horngren as embodiment of restrictive negative top-management attitudes cannot be doubled.

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