Marginal Costing and Break-even Analysis

Do you know that “marginal costing” is the gift of British? OK, with the chapter of we will deal about the marginal costing and break-even analysis.

Objectives:

Meaning of Marginal Cost and Marginal Costing

Concept of Contribution

Break-even Point and Margin of Safety

Break-even Charts

Applications and Limitations of marginal costing

About the definition of Marginal Costing ICMA London has defined as, “The ascertainment of marginal costs and of the effect of profit of changes in volume or type of output by differentiating between fixed costs and variable costs.”

In another word ICMA London define about marginal costs, “the amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit.”

Formula of Marginal costs:

Marginal cost = prime cost + total variable overheads

Or

Marginal cost = total variable cost.

Concept of Contribution:

Contribution called when selling price and marginal cost (variable cost) difference comes together.

Formula can be:

Contribution = selling price – variable (marginal) cost
Or Contribution = fixed cost + profit (or-loss)
Or Contribution – fixed cost = profit (or loss)

Thus,

Sales = Variable cost + fixed cost + profit (or – loss)
Sales = Variable cost = fixed cost + profit (or – loss)

In this chapter we have to read about P/V (Profit Volume) ratio also so here is P/V ratio calculation:

P/V = contribution/sales = S/C

Or = [Fixed Costs + Profit/sales] = [F+P/S]

Or = [Sales-Variable Cost/Sales] = [S-V/S]

Now, we will discuss about the Break-even Point:

Break-even Point is the representation position of that volume of sales or production which has no profit no loss. It means total sales are just equal to total cost.

The formula of the calculation of Break-even point is:

Break-even Point (units) = Total fixed costs/Contribution per unit [F/C per unit]

Break-even Sales = Total Fixed Costs x selling price per unit / contribution per unit
[F/C*S]

Fixed Cost/P/V Ratio [F/P/V]

Break-even chart shows the graphical representation of cost and revenue of inter-relation at different volumes of output.

About the advantages of Break-even chart no doubt that it helps to determine the selling price to give a desired volume of profit.

It shows costs and profits and different volumes of productions. But along with there are limitation of break-even chart also. About it people says that it always not shows true chart.

At last we can analysis about break-even and can say that it is the level of operations which is the position of cost and revenue equilibrium.

I think now, it is enough for marginal cost and break-even analysis from financial books. I will elaborate it more deeply with the further discussion where I will put some more examples also from finance and accounting books.

Understanding Cost from Financial Books

To explain about cost we start from the meaning of cost. According to Institute of Cost and management Accounts (ICMA) London in 1982, “the amount of expenditure (actual or national) incurred on, or attributable to a specified thing or activity.” According to the definition it is clear that cost may be the actual expenditure of national chares.

After the definition of cost we will go with the classification of costs:

1. Nature or Elements
2. Functions or Operations
3. Traceability
4. Variability or Behaviour
5. Controllability
6. Normality
7. Managerial Purposes

Now, we will explain about the costs along with graphs:

Fixed Cost graph:

Total Fixed Costs:

Unit Fixed Costs

Variable Costs known as also Linear Variable Costs. Variable costs graph shown as:

Linear Variable Cost

Non-Linear or Curvilinear Variable Costs graph:

Convex – linear Variable Cost

Concave – Linear Variable Cost

Semi-Fixed and Semi-Variable Costs

Semi-fixed Cost

Semi-variable Costs

Now, in the end of the chapter we can say all the things are clear which are in the chapter of costs. Most things are clear with the graph of costs. With the help of above mentioned graph we can conclude some decision in an organization. Cost is a part of CFS also in the financial chapter.