Question

What is break-even analysis? What is the difference between a linear and non-linear break-even analysis? Discuss the assumptions that underlie a break-even analysis, especially a linear break-even analysis, and explain what happens if the assumptions are relaxed?

Answer 1

Break even analysis is a function of sales volume, costs and profit. It gives a classification between the relationship of sales volume and total profit. Break even analysis tells us when the profits will be able to cover all the costs, that is a case of no profit, no loss.

Assumptions of this model are:

1. Total cost is equal to the summation of fixed costs and variable costs only.

2. Cost and revenue functions are linear

3. All prices are held constant

4. The level of technology and labour efficiency is the same

Differences:

Linear break even analysis talks about the minimum amount of output that is required in order to breakeven. It tells us that total revenue and total costs are equal in order to be at a break even point. Whereas Non-linear break even analysis is when the price is change with the level of output.

If assumptions are relaxed:

If all assumptions are relaxed in regards to linear break even analysis, it will behave like the non linear break even analysis as there will be a change in variables such as price and variable cost at each step.