Breakeven Analysis Case

• The breakeven analysis using the margin of safety is an invaluable tool to assess the impact of the risk of a change in revenue or costs. It is particularly useful for reviewing financial forecasts and business plans. This is illustrated as follows –

Forecast 1 Forecast 2 Forecast 3
A Sales volume in units 20000 25000 25000
B Selling price per unit $100 $100 $100
C Forecast revenue A x C $2000000 $2500000 $2500000
D Variable cost per unit @$60
E Variable costs A x D $ 1200000 $1500000 $1500000
F Contribution $800000 $1000000 $1000000
G Fixed operating costs $600000 $600000 $800000
H Net profit F – G $200000 $400000 $200000

Basing on the table able the breakeven sales revenues for a series of forecasts are computed as follow
The situation is not as serious in Forecast 2 and 3. e. Sensitivity testing
i. Sensitivity analysis is another simple financial tool used for assessing the impact of the risk of a change in selected variables such as selling price or cost of materials. This is useful for evaluating financial plans and forecast revenue or cash flow. Raw forecasts can sometimes be inaccurate, erroneous or unduly optimistic. For decision making and risk judgment purposes the sensitivity analysis provides alternative outcome given selected changes. ii. This tool can be used in conjunction with breakeven analysis which is illustrated above and for the evaluation of financial models that project into the future. It is best used by evaluating one variable at a time. It is not recommended to test more than two or more variables at the same time because this would not allow the analyst or user to see the impact of the particular risk item he or she is interested in. The following is an illustration of the use of sensitivity testing.

Sensitivity testing
Therefore the combination of both breakeven analysis and sensitivity testing provides a broader view of the financial forecast under varying circumstance. The following illustrates the use of margin of safety and breakeven analysis from the result of the sensitivity test on price and volume change using the data above.
Price variation
1 Revision in the breakeven situation Basic forecast Variation +10% price Variation -10% price Variation – 20% price
A Selling price $200 $220 $180 $160
B Production costs $160 $160 $160 $160
C Contribution @20% $40 $60 $20 $0
D Operating expenses $300000 $300000 $300000 $300000
E Breakeven sales (D÷C) A $1500000 $1100000 $2700000 not