# Break-even analysis in the process of investment planning, Break-even...

## Breakeven analysis in the process of investment design

The analysis of the break-even production in the context of targeted profit planning for the project is an integral part of effective investment design, since it allows the company to provide a principled opportunity to implement specific projects. This is provided by identifying so-called bottlenecks project in terms of achieving a given level of profit, which guarantees the required efficiency of the investment project.

The practice of investment companies shows that the most effective projects are those operating in a mode close to the full load of the estimated production capacity. If the project functions at a low level of using the estimated production capacity, the revenues received, as a rule, can not cover all the costs associated with the implementation of such an investment project. If the capacity utilization increases, the project gradually reaches a state where the total revenues begin to correspond to the total costs. This condition is called the breakeven state.

Breakeven analysis, or analysis of the ratio "costs - output - profit" (Cost, volume, profit, CVP - analysis) is one of the powerful analytical tools available to financial managers of companies.

Sometimes CVP -analysis is called the critical point method corresponding to that volume of production for a specific investment project, when which the company has neither profit nor loss.

This point is also called the dead, or breakeven point, or equilibrium point . In the economic literature it is often possible to find the designation of this point as VER , strong> ie. point of profitability (profitability).

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## Break-even model of production

The breakeven formula can be written as follows:

where TR - gross (total) income; TC - gross (common) costs; P - the price per unit of output; Q - quantity (volume) of products; FC - fixed production costs; A VC are the average (per unit of production) variable costs.

The essence of the break-even method is graphically illustrated in Fig. 6.5). By the way, a similar schedule could be built by putting off on the abscissa the output as a percentage of the total capacity of the project.

Mathematically, the breakeven point ( BER) can be clearly defined by the formula

The value (P - AVC ) in economic theory is called specific (per unit of output) Marginal profit. By the way, if its share (norm) in the product price is known, the breakeven point can be calculated (in money terms) as follows:

Fig. 6.5. Break-even schedule:

I - variable part of the costs (AV C- Q); II - fixed costs ( FC )

Example. Let the fixed costs associated with the implementation of the project for the production of a new product be \$ 6 million. The variable costs for manufacturing a unit of production are \$ 500. The estimated price per unit of output is \$ 1,500. What should be the minimum amount of the output to recover the entire amount gross costs?

Solution:

Break-even point for the example in question in monetary terms is

In the conditions of the project, connected with the production of several goods (services) simultaneously, the model of calculation of the break-even point considered above can be modified into multi-product. In this case, the equilibrium point for the whole project as a whole can be determined (in monetary terms) by the formula

where FC - the total fixed costs for the project; - total revenue from the sale of all products ι under the project;

- general variable costs; - margins

The national income associated with the implementation of the investment project; - the norm of marginal profit.

Analyzing this formula, it is easy to see that with the change in the structure of production (sales), all its components, except FC, will also change, thereby causing the corresponding changes in the values ​​of the equilibrium point (breakeven). This makes it possible, with the help of this model, to optimize the production structure by adopting, as a minimized criterion, the value of the break-even point, or the profitability threshold, of the project.

Knowing the profitability threshold for an investment project, a company can calculate its corresponding "financial strength margin".

Safety factor is the difference (absolute or relative) between the actual sales revenue and the profitability threshold in monetary terms.

Having such a "financial strength margin" will allow the company to withstand a corresponding decrease in sales revenue without a serious threat to its financial condition.

In practice, especially with a large nomenclature of production, as a rule, resort to a separate analysis of the break-even of various types of products. Constant costs are distributed by types of manufactured products in proportion to the volume of sales of specific products in monetary terms. Thus, if the purpose of the financial analysis is the calculation of the equilibrium point for each i-th product (service) separately, the following formula can be used for calculation:

where d i is the specific weight of the i product in the total revenue from the sale of products.

Example. Suppose that the implementation of a conditional investment project involves the production of three types of new products with the following characteristics of their production conditions, Table. 6.11.

Table 6.11

Baseline data

 Metrics Products Total A In From Sales, pcs. 50 100 50 Revenues from sales, USD 80000 100000 120000 300000 Total variable costs, USD 70000 80000 90000 240,000 Margin profit, \$ 10000 20000 30000 60000 Product specific gravity in total revenue 0.267 0.333 0.4 1.0 Total fixed costs, USD - - - 40000 Profit, \$ - - - 20000

For those listed in Table. 6.11 we have

The results of calculations show that the product A of its profitability threshold has not reached: it is unprofitable for the investment project product. Products In and With have exceeded their profitability threshold, thus compensating for losses from the A and providing a total project profit of \$ 20,000.

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