Assumptions of break-even chart
The followings are the assumptions of Break Even Chart.
1. All costs are divided into fixed and variable costs.
2. Fixed costs will remain constant and will not change according to the level of production.
3. Variable costs will change in direct proportion according to the level of production. In other words, the prices of variable cost factors will not charge in direct proportion to the level of production. They are wage rates, cost per unit of material and the like.
4. Selling price remain constant even though there exists competition or any change in the volume of production.
5. The number of units of production is equal to sales. It means that there is no opening or closing stock.
6. The operating efficiency of the company remains the same.
7. There is only one product or product mix in the case of many products will remain unchanged.
Advantages of break-even charts
The advantages of break-even charts are presented below:
1. The management can understand more information from the break-even chart than Profit and Loss Account and Cost Statements.
2. The relationship between cost, volume and profit of the company are simply presented in the break-even chart. It summarizes maximum information in a graph.
3. The chart is highly useful for taking valuable decisions by the management. The reason is that break-even chart shows the effect on profits of changes in fixed costs, variable costs, selling price and volume of sales.
4. The chart is very useful for forecasting costs and profits at various levels of production and sales.
5. The management exercises the cost control because it shows the relative importance of the fixed costs and the variable cost.
6. The chart helps the management to find the profitability of products and most profitable product mix.
7. Profits at different levels of activity can also be ascertained.
8. The chart helps to fix the selling price, which would give desired profit.
9. The effect of increase or reduction of selling price is known in the chart.
Disadvantages or Limitations of break-even chart
The following are some of the limitations or disadvantages of break-even charts.
1. A break-even chart is drawn on the basis of assumptions. But, the assumptions does not hold good. The fixed costs may vary beyond the certain level of operation. Likewise, the variable costs do not vary in direct proportion of the level of operation if the law of diminishing or increasing return is applicable in the business.
2. In the break-even chart, both total cost line and the sales line look straight lines. Since the assumptions does not hold good, these lines have not been drawn in straight lines in practice. It leads to several break-even points at different levels of activity.
3. Only limited information is available from the break-even chart.
4. A single break-even chart does not provide an opportunity to study the effect of various product mixes on profits.
5. In the case of managerial decisions, capital employed is taken into consideration. But, the break-even chart does not consider the capital employed. Hence, the managerial decisions can be a reliable one.
In spite of the above limitations, the break-even chart helps the management to take valuable and quality decisions.