(1) PARETO ANALYSIS

Introduction to Pareto Analysis in Excel

Pareto Analysis has a base of Pareto principle which says 80% of the effect

for a particular event (or many events in that case) has its roots in 20% of

the causes/reasons. It is most of the time remembered as 80/20

pattern/principle in laymen terms. This principle was first developed by an

Italian economist named Vilfredo Pareto and therefore it has been

named as Pareto Principle based on his name and at the same time, the

analysis being done is considered/named as Pareto Analysis. Some of the

real-life examples of Pareto can be formulated as below:

 80% of the shares of one particular company are owned by 20% of

the stakeholders.

 80% of the wealth is acquired by 20% of the people in this world.

 80% of the software issues are caused due to 20% of the bugs.

How to Create a Pareto Chart in Excel?

Suppose we have data as shown in the screenshot below. This data is

associated with a hotel and the complaints they receive from their clients.

As of now, they have several categories under which the complaints are

raised with the frequency of complaints as a parameter. Ex. If one

particular category has got complain once, the frequency will be one.

Every time a complaint gets raised under a category, the frequency

count gets raised by one unit. Therefore, when someone says the

frequency of complaint under a category is 40, it means 40 times a

complaint has raised under that category. See the screenshot below for

your reference.

Step 1: Under column C, capture the cumulative percentage. Cumulative

percentage can be captured using the formula as shown below:

Well, this formula seems somewhat weird for the naked eyes. However,

believe me, this is the best suitable formula for capturing the running totals

or cumulative sums.

Step 2: Drag this formula Across the cells C3:C8 in order to get the running

total of the frequencies in column B. You can see it as shown below:

Every time, the system captures the sum of frequencies starting from cell

B2 and up-to-the corresponding cell. For Ex. in cell C4, the sum value starts

from B2 to B4 and so on.

Step 3: In column D, find out the cumulative percentage with help of the

formula =C2/SUM($B$2:$B$8).
Step 4: Drag this formula down across the cells D3:D8 so that we can get

the cumulative percentage of frequency to proceed with our Pareto

chart. This can also be achieved using a keyboard shortcut Ctrl + D.

Step 5: Select the cells D2:D8 and navigate to the Number Formatting

group under the Home tab where you can see the Percentage Style

button. Click on that button to change the style of cells as a percentage.

Or else, you can press Ctrl + Shift + % button through your keyboard as a

shortcut to achieve the result.

You should see the cells under column D are formatted as percentage

values.
Step 6: Select column A, B and column D in your excel data and navigate

to Insert tab through Excel ribbon.

Step 7: Now, under Charts group click on the Recommended Charts

option. And you will see all the charts which can be used for representing

this data visually.

As soon as you click on Recommended Charts option under the Charts

section, a new window named Insert Charts will open up as shown below:
Step 8: In the Insert Chart window, click on the All Charts tab. Where you

can see a list of charts available to insert under Excel.

Step 9: Move towards the Combo option at the left-hand side and select

the Custom Combination under it to customize the chart.

Step 10: Now under Custom Combination, select and tick the Secondary

Axis option for Cumulative % series. It means that the Cumulative % values

will be plotted on the Secondary Axis. Click on the OK button once done.

See the screenshot below:

The final chart should look at the one below:

We would like to modify this chart to look like a Pareto chart. Follow the

steps below for the same.

Step 11: Right-click on the Secondary Axis values on the graph and

choose Format Axis… option. A new Format Axis pane will open up at the

rightmost side of the Excel sheet. There, under Axis Options, change the

Maximum value for Bounds to 1.0 it is automatically set for 1.2 which

means 120%.
If you will see any Pareto Chart, you’ll come up with an observation that

the gap between bars is really very less. Bars are close to each other. We

will try to reduce the gap between the bars of our Pareto chart.

Step 12: Right-click on any one of the bar and choose Format Data

Series… option placed at the end of the list of options.

Step 13: You can see on the right-hand side; the Format Data Series

window will open up in Excel. Under Series Options, You will have the Gap

Width option which can be managed custom. Change the Gap Width to

say 3% so that the bars get close to each other.

It actually looks like a Pareto Chart.

Here I have changed the color of the Cumulative % line series. Also, I have

added a chart title for this chart.

Based on our Pareto Chart, we can say that Almost 90% of the complaints

are raised for Delay in Room Service and Delay in Room Allocation.

Therefore, these are the major areas we should keep improving for better

customer feedback and reviews.

This is it from this article. Let’s wrap the things up with some points to be

remembered:

Things to Remember About Pareto Analysis in Excel

 In laymen terms, Pareto Analysis is also called as 80/20 principle.

 It is always good to capture the cumulative percentage of the

frequencies or data value and sort the data values in descending

order.

 Cumulative values should not be a part of the chart. Only

Frequency values and Cumulative Percentage should be a part of

the chart.

(2) Marginal Cost Formula

Marginal cost formula

Marginal cost formula is nothing but the mathematical representation to

capture the incremental cost impact due to a production of additional

units of a good or service. It is computed by dividing the change in total

cost due to the production of additional goods by the change in the

number of goods produced. Although the total cost is comprised of fixed

cost and variable costs, the variation in total cost due to a change in the

quantity of production is primarily because of variable cost which includes

labor and material cost. On the other hand, there might be few occasions

when there is increase witnessed in fixed costs which include

administration, overhead and selling expenses. Mathematically,

The marginal cost formula can be useful in financial modeling to arrive at

the optimum level of production required to ensure a positive impact on

the generation of cash flow.

Examples of Marginal cost formula

Let us consider a simple example where the total cost of production of a

company stood at $5,000 for the production of 1,000 units. Now, let us

assume when the quantity of production is increased from 1,000 units to

1,500 units, the total cost of production increased from $5,000 to $6,000.

Therefore,

 Marginal cost = ($6,000 – $5,000) / (1,500 – 1,000)

 Marginal cost = $1,000 / 500

 Marginal cost = $2 which means the marginal cost of increasing the

output by one unit is $2

Explanation of Marginal Cost Formula

Marginal cost formula can be determined by the following three simple

steps:

1. Compute the change in total cost

2. Compute the change in the quantity of production

3. Divide the change in total cost by the change in quantity produced

Change in total cost

At each level of production, the total cost of production may witness

surge or decline, based on the fact whether there is a need to increase

production volume or decrease the same. If the production of additional

units warrants an increase in the purchase cost of raw material and

requires hiring an additional workforce, then the overall production cost is

expected to change. To compute the change in total production cost,

just deduct the initial production cost incurred during the first batch from

the production cost incurred during the next batch when the output has

been increased.

Change in quantity produced

From a manufacturing unit’s point of view, it is quintessential to track the

quantities involved at each production level. A rise or decline in the

output volume production eventually is reflected in the overall cost of

production and as such it is important to know the change. To compute

the change in the quantity of production, the quantity of units produced

in the initial production run is deducted from the quantity of units

produced in the next production run.

Significance and Use of Marginal Cost Formula

In a perfectly competitive market, a company arrives at the volume of

output to be produced based on marginal costs and selling price.

Whenever a company performs financial analysis to arrive at product

pricing and check production feasibility, marginal cost analysis forms an

important part of the overall analysis based on which the management

can assess the price of each good or service being offered to consumers.

Now let us consider the following two scenarios to understand the

relevance of the marginal cost formula.

Scenario 1: Let us assume that the selling price for a product is greater

than the marginal cost of production, then in this scenario, the additional

production will generate incremental cash flow which is a valid reason to

increase the production.

Scenario 2: Let us assume that the selling price for a product is less than

the marginal cost of production, which means that the company will be

incurring losses and therefore either the additional production should not

be continued or the selling price should be increased. As such, marginal

cost formula forms an important part of business decisions pertaining to

continuation of production operations.

Marginal Cost Formula Calculator

You can use the following Marginal Cost Formula Calculator

Change in Total Cost 0

 Change in Quantity Produced 0

Marginal Cost Formula= 0

Marginal Cost =
Change in Total Cost = 0 = 0
Formula=

Change in Quantity 0
Produced

Marginal cost formula in Excel (With excel template)

The following table gives a snapshot of how marginal cost varies with the

change in quantity produced. Further, the graph for marginal cost

reverses trend after a certain when which indicates that after a certain

level of production the cost of production starts to increase after an initial

phase of moderation. At this stage, one needs to check if the cost of

production is less than selling price and if that is the case then stop the

incremental production.
Here we will do the same example of the marginal cost Formula in Excel. It

is very easy and simple. You need to provide the two inputs i.a change in

total cost and change in Quantity

You can easily calculate the marginal cost Formula in the template

provided.

First, we have find out change in total cost:

Then, we have find out a change in Quantity:

After that we get Marginal cost by using marginal cost formula:

(3) Marginal Revenue Formula
Marginal Revenue Formula

The formula for calculating Marginal Revenue:

Marginal Revenue (MR)= Change in Revenue / Change in Quantity

Where,

 Change in Revenue: It is the increase or decrease in the revenue in

a certain period of time.

 Change in Quantity: It is the increase or decrease in the number of

units in a certain period of time.

Marginal Revenue Formula – Example #1

Anand Machine Works Pvt Ltd. is a manufacturer of office printing &

Stationery items. Anand is currently planning to introduce the production

of a new category of pens. Currently, they are producing 400 pens and

sell them at $100 each. He has forecasted to produce 800 pens and will

be selling them at $150. We need to find the Marginal revenue of Anand

Machine works Pvt Ltd.

Here we have,

 Current No. of Units Produced: 400

 Current Revenue from Production: $100 each

Total Revenue from Production = 400 * 100 = $40,000

 Forecasted No of Units Produced: 800

 Forecasted Revenue from Production: $150

Total Revenue from Production = 800 * 150 = $1,20,000

We can calculate Marginal Revenue by using the below formula

Marginal Revenue (MR)= Change in Revenue / Change in Quantity

 Marginal Revenue = ($1,20,000 – $40,000) / (800 – 400)

 Marginal Revenue = $80,000 / 400

 Marginal Revenue = $200

Marginal revenue of Anand Machine works Pvt Ltd is $200.

Explanation of Marginal Revenue Formula

Marginal revenue can be defined as the increase in revenue, as a result

of the one additional unit sold. Over a certain level of output, Marginal

revenue can remain constant as it follows the law of diminishing returns

and Marginal revenue can eventually decelerate as the output level

increases. Firms in the perfect competition market continue producing

output until marginal revenue equates marginal cost.

We can calculate marginal revenue for a company by dividing the

change in total revenue by change in total output quantity produced by

the company. Marginal revenue equal to the sale price of a single

additional item sold.

Change in Revenue is the increase or decrease in the revenue in a

certain period of time. Change in Quantity is the increase or decrease in

the number of units in a certain period of time.

Relevance and Uses of Marginal Revenue Formula

For the companies in the Manufacturing Industries, marginal revenue

plays a huge role in determining the production levels and product

pricing.

Let’s take an example, the Market price is equal to Marginal revenue in a

truly competitive market where the manufacturers are selling

homogenous products, mass-produced products. In other words, we can

say that the manufacturers of the differentiated products and

commodities have to sell the products at the market price as they are

selling in the competitive market place. The consumer can shift to any

other competitor in case a manufacturer raises its price of the product.

Let’s take the example of a farmer who sells barley. The cost of barley is
set by the market every year. If he tries to sell the barely above the market

price, then consumers will shift to its competitors as barley is not a

differentiated product from other farmers.

However, this is inverse in case of highly specialized products where the

production and output of the commodities or products are low. There are

limited alternatives available for the products, the selling price is affected

by the production level of the product. This means if the demand will be

increased by supply and consumer will be ready to pay higher prices.

Company adjust their output and restructure its pricing to optimize their

profitability.

Marginal Revenue formula also plays a vital role in the invention of the

Profit Maximization Rule. It states that a firm should select the level of

output where marginal revenue is equal to the marginal cost to maximize

its profits.

The profit maximization formula: Marginal Revenue = Marginal cost.

Where, Marginal Cost is the increase in cost, as a result of producing one

additional unit of the product. Marginal revenue can be defined as the

increase in revenue, as a result of the one additional unit sold.

Marginal Revenue Formula Calculator
You can use the following Marginal Revenue Calculator

Change in Revenue 0

Change in Quantity 0

Marginal Revenue Formula 0

Marginal Revenue =
Change in Revenue = 0 = 0
Formula
Change in Quantity 0

Marginal Revenue Formula in Excel (With Excel Template)

Here we will do the example of the Marginal Revenue formula in Excel. It is

very easy and simple.

You can easily calculate the Marginal Revenue using Formula in

the template provided.

Let’s assume Anand Group of Companies Financial has shown the

following details. Now we need to calculate the Marginal Revenue for

Anand Group of companies. for this financial year on the basis of the

below data.
We can calculate Marginal Revenue by using the below formula

Marginal Revenue (MR)= Change in Revenue / Change in Quantity

 Marginal Revenue = (2,50,000 – 2,00,000) / (3,000 – 1,500)

 Marginal Revenue = 50,000 / 1,500

 Marginal Revenue = $33

 (4) Rule of 72 Formula

Rule of 72 Formula

Compound interest is the eighth wonder of the world. -Albert Einstein

The investment gives multiple times return on the invested amount if

interest is calculated compounding.

For example – With 25% simple interest, in 3 years it will give 75% returns but

if we calculated it compounding it will give 95% returns.

Doing this calculation mentally will be strenuous, but formula 72 can help

in doing this calculation mentally.

Here’s the Rule of 72 formula –

Where,

r = the Rate of Return

The “Rule of 72 formula” is a shortcut method of calculating how long

it will take compounding interest to double an invested amount.

Or in other words –

The rule of 72 formula is a mathematical way to calculate the number of

years it will take for investor money to double with compounding interest.

In other words, it is an easy method to calculate how long investor money

has to be invested in order to double at a specified interest rate.

Examples and Explanation

The rule of 72 is a method used in finance or investment to quickly

calculate the halving or doubling time through compound interest

or inflation, respectively.

72 / [periodic interest rate] = [number of years to double principal amount]

Example #1
For example, using the rule of 72, an investor who invests $2,000 at an

interest rate of 8% per year, will double their money in approximately 9

years.

By using the formula of 72 rule, we get –

 Rule of 72 = 72/r

 Rule of 72 = 72 / 8

 Rule of 72 = 9

Example #2
Investor, who invests $10,000 at compounding interest rate at 4% per year,

will double his money in approximately in 18 years.

By using the formula of 72 rule, we get –

 Rule of 72 = 72/r
  Rule of 72 = 72 / 4

 Rule of 72 = 18

The same formula can be used to find out inflation effect on the amount –

72 / [inflation rate] = [number of years to half the principal amount]

Example #3
Using the same rule of 72 formula as stated above, an investor who invests

$10,000 with an annual inflation rate of 1 % will lose half of their principal in

72 years.

By using the formula of 72 rule, we get –

 Rule of 72 = 72/r

 Rule of 72 = 72 / 1

 Rule of 72 = 72

The rule of 72 can also be used to demonstrate the long-term effects of

period fees on an investment, such as life insurance, mutual funds,

and private equity funds. For example,

Example #4
Not counting any appreciation of the underlying investments in the fund,

a mutual fund with a 6% annual expense and loading fee on principal

invested will cut the principal in half over 12 years.

By using the formula of 72 rule, we get –

 Rule of 72 = 72/r

 Rule of 72 = 72/ 6

 Rule of 72 = 12

The rule of 72 is an approximation. It is not exact. Indeed, the rule of 72 is

accompanied by the rule of 70 and the rule of 69 which are used the

same way but are more accurate for smaller periodic interest rates. The

rule of 72 is popular because it is divisible for more numbers (i.e. possible

interest rates).

Interest Rate Number of years invested to double the princ

1 72

2 36
3 24

4 18

5 14

6 12

7 10

8 9

9 8

10 7

11 7

12 6

13 6
14 5

15 5

16 5

17 4

18 4

19 4

20 4

21 3

22 3

23 3

24 3
 25 3

Note – Rule of 72 formula gives an approximate number of years not the

exact number of years.

It is important to note, that the rule of 72 formula definition requires that

the interest is compounded only annually. This method will not work for

investments with a quarterly or semi-annual compounded interest rate as

it is. If you want to use this method for investment returns for a quarterly or

semi-annual compounded interest rate as it is, you will need to modify it.

Significance and Use of Rule of 72

While this calculation is relatively simple with a calculator or spreadsheet,

the rule of 72 formula, which was derived before the 14th century, is useful

now also for mental calculation for the effects of compound interest.

Investors generally use this calculation method when calculating the

differences among similar investments or effect of inflation on an amount.

Investors want to see their investments grow multiple times, so investors

can think to invest in more opportunities in the future. This rule can be used

on any type of investment not necessarily stock market or mutual fund

investment.
Even average American or any other citizen can use rule 72 method to

calculate the amount of savings or money retiree will have in a retirement

fund or how much their share in a mutual fund or any other investment will

be worth in five years, ten years or fifteen years. The rule 72 will help to

calculate how long it will take to double your money in an investment

corpus. In other words, it is an easy, very limited future value calculator

that will calculate the value of an investor’s money in the future.

This rule 72 is a very helpful shortcut method because the investment

equation for compounding interest is complicated and long. Anyone can

use this simple rule of 72 formula as a basic estimate for investments return

calculations.

Rule of 72 Calculator
You can use the following Rule of 72 Calculator

Rate of Return (r) 0

Rule of 72 = 0
 Rule of 72 =
72 72

= = 0

Rate of Return (r) 0

Rule of 72 Formula in Excel (With Excel Template)

Here we will do the same example of the Rule of 72 in Excel. It is very easy

and simple. You need to provide only one input i.e Rate of Return

You can easily calculate the Rule of 72 using Formula in the template

provided.

By using the formula of 72 rule, we get –

(5) S CURVE in Excel

What is S CURVE in Excel?

A type of curve that shows a graphical report of cumulative progress of a

project with reference to time & the growth of a variable in terms of

another variable, often expressed as units of time. It is helpful for real-

estate builders & developers to track & implement different phases of the

project in their ongoing building project, where it will help out to finish the

ongoing project within scheduled time & with the allocated budget. It is

also useful to track the project timeline and its costs in the IT & pharma

company (With daily progress report).

You can easily keep an eye on Project progress on a daily or monthly

basis with the S CURVE implementation (it’s a measure of productivity)

Cumulative Value of Work Progress with Reference to Time

In S curve of any building project, at the beginning, where work starts in a

relatively slower pace, then it picks up slowly, in the middle phase you can

observe the rapid pickup, and in the final phase, it gradually slows down,

final work tasks go in a slower phase.

Similarly, in the case of the S curve for a new product launch & its

progress, in the initial phase of the curve, the rapid initial growth of

company sales for a new product can be seen, i.e. exponential increase

in sales for a specific period time, later part of the curve, you can see a

leveling off or taper off. This phase occurs when the population of new
customers declines. At this point, you can observe negligible or slower

growth rate and is sustained for a longer duration with an existing

customer who continues to purchase or buy the product.

How to Create S CURVE in Excel?

Let’s look at a few examples on how to work on S CURVE in Excel.

Example #1 – S CURVE Creation for Building Project

In the below-mentioned table, I have project task list and amount

allocated for each task in the building project in the column “C” & “D”,

here I need to calculate the total amount of each task in that range (D3

to D6), in the cell “D7” by applying sum formula. i.e. =SUM(D3:D6)

Once it is done, we need to convert the amount of each task allocated

to percentage allocation for computing & for S curve preparation. Now,

enter the formula to get a percentage allocation for each task i.e. by

dividing each task with the total amount allocated e.g. in the cell E3 type

=D3/$D$7
Here D7 reference is made absolute or locked so that the formula is

applied to other cell references.

The output values are converted to percentage format with format cells

option.
Now, enter the details of the allocated task timeline for each task (in

weeks) & its duration.

Now, we need to distribute percentage allocation of work on a weekly

basis, prorated work percentage distribution for each week. Let’s apply

for the first task activity in the cell “I3”, i.e. Allocation percentage for that

task divided by total duration or timeline for that task (In weeks)

=$E$3/$H$3

Here we need to lock both the cell reference in the formula or make it an

absolute reference and drag it other colored cells (I3 to M3) to apply the

formula. The output values are converted to percentage format

with format cells option. Similarly, it is followed & applied to other 3 tasks

allocation also, to get the correct distribution of percentage allocation of

work on a weekly basis in a respective cell

After calculation of percentage allocation of work on a weekly basis, we

need to gets the total for a weekly percentage of work done on a weekly

basis (from week 1 to week 8) with help of sum function E.G. For week 1,

let’s apply sum function for the total percentage of work done.

i.e. =SUM(I3:I6) for a week 1 total work progress

Similarly, step is followed until a week 8 work progress to get the

distribution of percentage allocation of work on a weekly basis. Apply the

sum function or formula to other cell references also i.e. (from I9 TO P9 cell

reference), by dragging it till week 8.

Once we obtain weekly progress data, we need to calculate Cumulative

progress for each week. Now, let’s calculate Cumulative progress, from
the cell “I10”. In the cell “I10” add cell reference “I9”, and in the cell “J10”

add the cell value of “I10” and “J9” to get the cumulative progress. Now

you can drag or apply this formula till “P10” cell to get the cumulative

progress for each week with reference to weekly progress

Now, I can use this cumulative work progress for each week to create an

S curve chart. So to Create an S Curve chart, Select the cumulative work

progress from week 1 to week 8 & simultaneously by pressing CTRL key to

select the cells from week 1 to week 8.

Once both the cell ranges are selected, go to insert option, under that

select line with markers option chart.

Now, you can carry out the formatting of the chart.

You can edit and change the title text of the chart to S CURVE. In the

Vertical axis, we can change the vertical limit from 120% to 100% with

format axis options, in the format axis change the maximum value under

the bond option from 1.2 to 1.0

Simultaneously, we can change the data series name to cumulative

progress, by right click on the chart area, select the edit option under
legend entries. Now edit series window appears, in the series name box

you can enter a cell reference of cumulative progress i.e. “C10”

Now the S curve is ready.

You can simultaneously plot another data series i.e. standard one

(planned work progress) to compare with actual work progress to track

how the project is moving on

Things to Remember About S CURVE in Excel

 It helps in the adoption of a new product launch & its progress rate.

 From S curve, you can also plat a graph for Actual costs against the

planned budget cost for any project work.

 To draw the S curve, you can either use a Scatter Chart or Line

Chart.
 (6) Break Even Analysis
Example

Introduction to Break Even Analysis Example

Break Even Analysis is a tool that helps a company to decide at which

stage the products or services provided by the company will start making

profits. To put it in simple language it is a tool that will help a company

decide how many products or services they should sell to cover the costs.

This is a stage where there is no profit and no loss and only covers your

cost. The costs covered in this calculation are mainly fixed. Lower fixed

costs will lead to lower break-Even value.

Break-Even is calculated as

Break-Even= Fixed Cost / Contribution per Unit

Break-Even Analysis Example – #1

Let us look at a simple example which uses the above formula to

calculate Break Even cost:

Solution:

A Contribution per Unit is calculated by using the formula given below

Contribution per Unit = Selling Price – Variable Costs

  Contribution per Unit = $600 – $400

 Contribution per Unit = $200

Break Even Point is calculated by using the formula given below

Break-Even = Fixed Costs / Contribution per Unit

  Break-Even = $1000,000 / $200

 Break-Even = $5,000

Total Sales Required to Achieve Break Even Point is Calculated as

Total Sales = Break-Even Point * Selling Price per unit

  Total Sales = $5,000 * $6,000

 Total Sales = $3,000,000

To calculate contribution per unit we have subtracted selling price and

variable costs. Now to calculate the break-even point i.e. how many units

we will require to achieve the break-even, we will divide $10,000 to

contribution per unit of $200 which leads us to 5000 units. To calculate the

total sales in $ terms we will multiply the units required with the selling price

per unit.
Break-Even Analysis Example – #2
Let us look at an example of break-even analysis by plotting total cost

and total revenue equations on the graph, which is known as a Break-

even graph. We will plot the output on the horizontal axis and costs and

profit will be plotted on the vertical axis.

Franco Co-operation makes iron benches and wants to determine the

break-even point. The total fixed cost for his business is $60,000 and the

variable cost is $40 per bench. He sells the bench for $100 per unit.

Solution:

A Contribution per Unit is calculated by using the formula given below

Contribution per Unit = Selling Price – Variable Costs

  Contribution per unit = $100 – $40

 Contribution per unit = $60

Now let’s calculate the number of benches Franco needs to achieve

Break-Even

Break-Even Point is calculated by using the formula given below

Break-Even = Fixed Costs / Contribution per Unit

  Break-Even = $60,000 / $60

 Break-Even = 1000 benches

When Franco produces 1500 benches the total cost is $120,000 and the

total revenue is $150,000.

The break-even point is where total costs equal total revenue and in this

case, it is at $100 * $1000 = $100000

At a level below the Break-Even, losses are incurred, this is because total

costs are greater than total revenue. If 500 units are produced a loss of

$30,000 are incurred

The below table shows the fixed costs, variable costs, total costs and profit

generated when a certain number of units are sold

The above graph highlights the total cost and profit. The point where

these lines intersect is known as the Break Even Point. As we go below the

graph, losses are made and as we move on the upper side the profits

increase. Profits increase as output rises. At an output of 1500 profit of

$30,000 is made. Also, the relationship between fixed and variable costs

can be observed in the above table, the lower output will have a higher

proportion of fixed costs

Break-Even Analysis Example – #3

Below is the income statement provided by a firm for a month.
Let us now first calculate the break-even output

Break-Even Point is calculated by using the formula given below

Break-Even = Fixed Costs / Contribution per unit

  Break-Even = Fixed Cost / (Selling Price – variable Costs)

 Break-Even= 27300 / (80 – 67)

 Break-Even = 2100

If the variable costs increase by $4 what will be the change in the break-

even point?

An increase in variable costs of $4 makes the variable costs to $71. The

break-even point moves up to

Break-Even Point is calculated by using the formula given below

Break-Even = Fixed Costs / Contribution per Unit

  Break-Even = Fixed Cost / (Selling Price – variable Costs)

 Break-Even = 27300 / (80 – 71)

 Break-Even = 3033

Break Even Analysis Example – #4

Let us now look at an example where we will calculate the break-even

point for multiple products.

Cafe Brew wants to calculate the break-even point for next year based on

the data given below. As indicated below, 50% revenue comes from

selling coffee and the remaining 50% comes from selling chocolate and

latte. The respective selling price are given below

In the second table, we have variable costs related to each product and

the total fixed costs of $55000

The weighted average price is calculated by multiplying each weight with

the price and by summing up all these values.

Weighted Average Price is calculated as

  Weighted Average Price = $55000 / ($3.35 – $0.57)

 Weighted Average Price = 19784 units

Conclusion
Break even analysis may be a useful tool but it has its limitations. It is often

criticized for being too simplistic and based on unrealistic assumptions.

For example, it assumes that all the output or the stock is sold and no

stock is left. However, in reality, many business stocks pile their inventory. It

assumes that the conditions remain the same. Moreover, the calculation
depends on the accuracy of the data. In the case of a multi-product

business, there may be many variable costs at one time.