Limitations of break-even analysis
Break-even analysis looks to be a very valuable and useful aid to decision making. Certainly, break-even charts are relatively easy to build and carry out managers with info on break-even forecasts, margins of safety and profit and also loss at various output levels. Manipulation that break-even charts can be used to answer; "what if?" questions and also can be component of a strategy analysis, including the setup of prices and also establishing the source levels required to struggle target profits.
However, there space a variety of limitations of break-even analysis.
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Evaluation of break-even analysis
Examiners favor break-even inquiries as castle are relatively easy come set, and require student to show numeracy skills. However, over there are numerous assumptions in the break-even process that might limit its usefulness:All calculation is sold: break-even functions on the basis that all calculation is turned right into sales revenue. In reality, that company will have stocks the unsold items at any one time, unless they deserve to work top top a completely just-in-time basis.One product and also price: most businesses sell an ext their products at various prices in various markets and to different customers. Customers that buy in bulk, for instance will be licensed has been granted to a discount. Break-even ignores all economies of scale.Straight line costs and revenue curves: if a firm is compelled to take on lower price at higher output since the industry is coming to be saturated, climate the revenue curve will certainly not be a right line. Likewise a firm"s typical variable prices are likely to be lower at greater outputs as it can negotiate a discount native its suppliers. The straight line presumption also method that semi-variable prices are assumed come be directly proportional come output and also in essence are simply lumped together with other variable expenses - in truth the term semi-variable is not offered at all.
These assumptions mean the break-even analysis is just valid over a little range that outputs or sales and with solitary product firms.
What happens when a certain makes more than one product? Let"s look in ~ an example:Maze environment-friendly Yachts Ltd
This firm has been collection up to produce a brand-new plastic fun boat. The expense profile is offered below.
Fixed costs per month: $100 000Variable expenses per boat: $100Selling price that boat: $300
Now draw the break-even chart, and also then click graph to see if girlfriend have acquired it correct.
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Now the service expands and also introduces a brand-new model. The expense profile is now:
Fixed costs per month $150,000Variable costs boat A: $120 per boat, boat B: $160Price watercraft A: $350, boat B: $460
If you try and draw the charts, you will hit a trouble instantly: exactly how to decision on i beg your pardon fixed costs go with which boat. Girlfriend cannot work-related this the end accurately, so girlfriend cannot attract break-even charts. This is a significant drawback the break-even charts and also analysis, as it yes, really only uses to solitary product firms.
Some this firm may pick to apportion these costs using full-costing or absorption costing and conduct as different break-even for each boat. The result may be quite inaccurate and is just as good as the an approach used to apportion the costs.