Understand The Assumptions And Limitation Underlying Break-Even Analysis

Like all other financial/costing model, break-even analysis using break-even chart to understand the business’s break-even point has also certain assumptions and limitations underlying it.

Some Of the Assumptions & Limitation are as follows:

1.0 It assumes that fixed costs remain the same at different level of activity

2.0 It assumes that the total cost line is shown as a straight line when in actual fact, costs do not usually vary in direct proportion to volume. Each unit produced and sold may not necessarily incur the same variable cost as attempts to sell more units may increase the variable cost at a faster rate than activity

3.0 It assumes that revenue is perfectly variable with activity, showing a straight line on the break-even chart which is unrealistic as very often in order to increase sales volume, it may be necessary to give extra discount or reduce the selling price. The sale revenue line will therefore no longer be linear but curved.

4.0 Break-even charts are only true within the minimum and maximum ranges of activity. Any attempt to determine figures outside this range of activity is not valid

5.0 Break-even analysis assumes that all units produced are sold

6.0 Break-even chart has a life span as the nature of variable and fixed cost change with time. It would then be necessary to construct new charts based on different circumstances

7.0 In a multi-product firm, each possible product mix will tend to incur different costs so that with any change in the product mix, a new break-even chart is required. Thus in a break-even chart of such firm, the sales mix is assumed to remain constant throughout its level of activity

8.0 It assumes as in conventional accounting that monetary values are stable. In order to establish the break-even point in real terms it may be necessary to adjust revenues and costs to current purchasing powers.