BREAK EVENT POINT ANALYSIS AND PRICE DETERMINATION
ARIZONA STATE UNIVERSITY
TMC 410 - ENTERPRISE OPERATIONS
SPRING 2024
Introduction:
The important role of information in the business world lies in the effectiveness of the
information used by management. Information viewed from the management point of view
can function to help drive and develop company activities. The survival and growth of a
company depends on the management accounting information system (Mulyadi, 1993).
Break even point (BEP) in Indonesia is known as break-even point, which is one of the
many forms of management accounting information used in analyzing the relationship
between revenue/sales, costs, volume, and profit.
Break even point analysis is very important for company leaders, useful for knowing
the level of production, among others, in determining the amount of sales or how far
managers know the company's break even point. Managers will be more aware of the
relationship between sales, production, selling prices, costs, loss or profit, their company,
making it easier for them to take policy. In general, break-even point analysis techniques are
already owned by all business people. It is very useful for a wide range of business settings,
including small and large organizations.
A. Basic Concept:
1. Definition of Break Even Point
Break even point in a company is the state of the company whose operations do not
make a profit and do not experience a loss or the total cost expenditure is equal to the total
sales results so that there is no profit and no loss.
According to Djarwanto (2002), break even point is a state of break-even, which is
when the calculation of profit and loss for a certain period has been prepared, the company
does not make a profit and does not suffer a loss.
According to Harahap (2004), break even point means a situation when the company
does not experience profit and does not experience loss, meaning that all costs incurred for
this production activity can be covered by sales revenue. Total costs (fixed costs and variable
costs) are equal to total sales so there is no profit no loss.
Another case with Garrison and Noreen (2004) that the break even point is the level of
sales needed to cover all operating costs, namely when the break even profit before interest
and tax is equal to zero.
S. Munawir (2002) states that the break even point or cost recovery point can be
interpreted as a situation when the company's operations do not make a profit and do not
suffer a loss (total income = total costs).
According to Jumingan (2006: 183), "Break even point analysis is needed to determine
the relationship between production volume, sales volume, selling price, production costs,
other costs that are fixed, variable, and profit or loss."
One of the efforts to achieve the maximum possible profit can be done with three steps,
among others:
a. Keep production or operating costs as low as possible while maintaining price, quality,
and quantity levels;
b. determine the price according to the desired profit;
c. increase the volume of activity as much as possible.
The steps mentioned above cannot be taken separately because the three factors have a
close relationship and are synergistically interrelated. In other words, one of the problematic
factors will have an impact on the entire operation.
Therefore, the profit structure of and by a company is depicted in terms of break even
points, making it easy to understand the relationship between costs, volume of activities, and
profits.
2. Understand Break Even Point Analysis
According to Abdullah (2004), break even point analysis is also called cost volume
profit analysis. The importance of break even point analysis for company managers,
especially in considering financial decision making.
In its capacity, break event analysis is an analytical technique to study the relationship
between fixed costs, variable costs, profits, and volume of activity.
The position of a company with a certain production volume can suffer losses because
its sales revenue is only able to cover variable costs and cover a small portion of fixed costs.
Thus, the significance of a break even point analysis, among others:
a. to determine the minimum amount that must be produced so that the company does not
incur losses;
b. to determine the number of sales that must be achieved to earn a certain profit;
c. to determine whether the decline in sales can be tolerated so that the company does not
suffer losses.
According to Rony (1990: 357), break even point analysis is very useful for
management in explaining some important operational decisions in three different but related
ways, namely:
a. consideration of new products in determining the level of sales that must be achieved
for the company to make a profit;
b. as a basic framework for research on the effect of expansion on operational levels;
c. assists management in analyzing the consequences of shifting variable costs to fixed
costs due to the automation of work mechanisms with sophisticated equipment.
3. Understanding the Foundation of Break Even Point
Another meaning of understanding the foundation of break even point, including the
steps to determine break even, is to divide the cost of goods sold (COGS), and operating costs
into fixed costs and variable costs. Fixed costs are a function of time, not a function of the
amount of sales and are fixed by contract, such as warehouse rent. Variable costs, on the
other hand, depend on sales and are not a function of time, such as the cost of transporting
goods.
If a company only has variable costs, the problem of break even point in the company
will not arise. The break even point problem will arise if a company has variable costs and
fixed costs.
The amount of variable costs in totality will change according to the company's
production volume, while the amount of fixed costs in totality does not change despite
changes in production volume.
With variable costs and fixed costs, a company with a certain volume of production is
said to suffer losses because sales only cover fixed costs. This implies that part of the
proceeds from sales that available is only enough to cover costs, meaning it is not enough to
cover its variable costs.
If it is known that the value of sales volume or total income is equal to the value of total
costs, so that the company does not achieve profit or profit and does not suffer losses, it is
called a break even point.
4. Benefits of Break Event Point Analysis
Matz, Usry, and Hammer (1991: 224) explain the benefits of break even point analysis
for management purposes, namely:
a. to assist control through budgets,
b. to increase and balance sales,
c. to analyze the impact of volume changes,
d. to analyze selling prices and the impact of cost changes,
e. to negotiate wages,
f. to analyze the product mix,
g. to accept the decision of capitalization and continued expansion,
h. to analyze margin of safety.
According to Sigit (1993: 1), break even point analysis has several benefits, including:
a. as a basis for planning operational activities in an effort to achieve certain profits,
b. as a basis or foundation for controlling ongoing activities,
c. as a consideration in determining the selling price,
d. as a material or basis for consideration in decision making.
Break even point can also be used for various purposes, especially for companies that
are planning. In addition, break even point can also be used as a control tool when the
company is still in activity before the end of a period.
In line with this, Sigit (1996: 3) also states the various benefits of break even point
analysis, namely:
a. as a tool for planning profits,
b. as a tool for budget planning,
c. as a determinant of the selling price of the product,
d. as a basis for determining the selling price of the product,
e. as the basis for the development plan,
f. as a basis for decision-making.
Based on the description above, it can be concluded that the benefits of break even
point analysis include:
a. can be used as a tool to provide information to management in a simple and concise
manner;
b. break even point analysis can be used as a guiding tool in making decisions regarding
costs, revenues, and cost planning;
c. can provide an overall picture of expected costs and product yields in the company's key
activities for the foreseeable future;
d. can be used as a basis for controlling ongoing operational activities, namely as a means
of realization with calculations based on break even point analysis as a controlling tool;
e. can be used as a consideration in determining the selling price, namely after knowing the
results of calculations according to the break even point analysis and targeted profits.
5. Weaknesses in Break Event Point Analysis
In accordance with its characteristics, break even point analysis not only brings benefits
and uses, but also has weaknesses. In accordance with the statement of Sofyan Syafri
Harahap (1997: 364), the weaknesses in BEP analysis include the following.
a. The assumption that the selling price is constant, when in reality this price must
sometimes change according to the forces of demand and supply in the market.
b. The assumption of the classification of fixed and variable costs also contains
weaknesses. In certain circumstances, to meet sales volume, costs must change due to the
purchase of machinery and other equipment. Likewise, the calculation of variable costs
per unit will be affected by these changes.
c. Fixed costs are not always fixed at various capacities.
d. Variable costs do not always change in line with volume changes.
Although break even analysis is widely used by companies, it cannot be forgotten that
this analysis has several weaknesses. The main weaknesses of break even point analysis
include assumptions about linearity, cost classification, and its limited use for short periods
of time.
a.
Assumptions about Linearity
In general, selling price per unit or variable cost per unit is not independent of sales
volume. In other words, the level of sales that passes a certain point is only achieved by
lowering the selling price per unit. This will certainly cause the renevue line not to be
straight, but curved. In addition, the variable operating cost per unit will increase as the sales
volume approaches full capacity. This could be due to a decrease in labor efficiency or an
increase in overtime wages.
b.
Cost Classification
The second weakness of break even point analysis is the difficulty in classifying costs
due to the existence of semivariable costs, i.e. these costs are fixed up to a certain level and
then change after passing that point.
c.
Usage Period
Another weakness of break even point analysis is its limited period of application,
usually only used in making operating projections for a year. If the company incurs costs for
advertising or other costs that are quite large, but the results of these expenditures (additional
investment) are not visible in the near future, while operating costs have increased, as a
result, the amount of revenue that must be achieved according to the break even point
analysis in order to cover all operating costs has also increased.
Thus, it can be concluded that the break even point analysis includes the following.
1) BEP analysis requires assumptions, especially regarding the relationship between costs
and revenues.
2) BEP analysis is static, meaning that it is only used at a certain point, not at a certain
period.
3) BEP analysis is not used to make a final decision, but is used if there is a determination
of further activities that can be carried out.
4) BEP analysis does not provide a good cash flow test, meaning that if the cash flow has
been determined to exceed the cash flow to be incurred, the project can be accepted and
all other things being equal.
5) BEP analysis pays little attention to risks that occur during the sales period, such as
rising raw material prices.
B. Break Event Point Assumption:
1. Basic Assumptions of Break Even Point Analysis
Understanding the basis of break even point analysis begins with looking at the
assumptions that influence break even point analysis. Therefore, Mulyadi (1993: 259)
explains that several assumptions that influence BEP include:
a. cost variability is considered to be close to the predicted behavior pattern;
b. the selling price of the product is considered unchanged at various levels of activity;
c. the production capacity of the factory is considered relatively constant;
d. the prices of the factors of production are assumed to be unchanged;
e. production efficiency is considered unchanged;
f. changes in the beginning and ending inventory amounts are considered insignificant;
g. the composition of the products sold is considered unchanged;
h. volume is the only factor that affects cost.
Break even point analysis will be useful when some basic assumptions are met,
including the following.
a. Costs at different levels of activity can be estimated precisely. Changes in production
levels can be translated into changes in cost levels.
b. Costs that can be estimated are separated from those that are variable and are fixed
costs. A break even analysis can only be calculated if some costs are fixed costs.
c. The sales level is the same as the production level, meaning that what is produced is
considered sold out. Thus, the level of finished goods inventory does not change or the
company does not provide finished goods stock.
d. The selling price of the company's products at various sales levels does not change.
This means that the market is perfect or the company's market share is so small that it is
unable to change the market price.
e. The efficiency of the company at various levels of activity also does not change, so the
variable cost of each unit of product is the same for various production volumes.
f. There were no changes to the various management policies that directly affected the
overall fixed costs. As such, the overall fixed costs are also unchanged.
g. The company is considered as if it only sells one kind of final product. If in reality
more than one product is made, the sales mix is kept the same.
In reality, many more assumptions cannot be met. However, these changes in
assumptions do not diminish the validity and usefulness of the BEP analysis as a decision-
making tool. Therefore, certain modifications are required in its use.
2. Assumptions Limitations of BEP Analysis
It is known that one of the limitations of the BEP analysis is due to the many
assumptions underlying this analysis. On the other hand, these assumptions are necessary if
the analysis is to be conducted quickly and accurately. The assumptions made are sometimes
too forceful and the accountability is often overstated. Therefore, managers consider that
these assumptions must still be made and are one of the limitations of BEP analysis. The
limitations of assumptions in BEP analysis include the following.
a. Cost in BEP analysis
In BEP analysis, only two kinds of costs are used, namely fixed costs and variable
costs. Therefore, in starting BEP analysis, it is necessary to start by separating the
components between fixed costs and variable costs.
Separating the two costs is relatively difficult due to the existence of semivariable and
fixed costs. Separating the two costs can be done through the following two approaches.
1) Analytical approach, which must examine each type and element of cost contained one
by one of the existing costs and the properties of these costs.
2) The historical approach, which requires the separation of fixed and variable costs based
on past cost figures and data.
b. Fixed Cost
Fixed costs are costs that in total do not change, despite changes in production or sales
volume (within certain limits). That is, costs remain constant up to a certain capacity, i.e. the
production capacity owned. For example, salaries, depreciation of fixed assets, interest, rent
or office costs, and others.
c. Variable Cost
Variable costs are costs that change in total according to changes in production or sales
volume. This means that the variable cost assumption changes proportionally with changes in
production or sales volume. This is difficult in practice because in large sales there will be
certain deductions, both received and given by the company. For example, raw material costs,
direct labor wages, sales commissions, and others.
d. Selling Price
The selling price is only used for one kind of selling price or the price of the goods sold
or produced.
e. No Change in Selling Price
The selling price per unit cannot change during the analysis period. This is contrary to
the actual condition, where the selling price in a period can change along with changes in
other costs that are directly or indirectly related to the product.
3. Purpose of BEP Analysis
In general, one of the company's goals is to achieve profit or profit in accordance with
the company's growth.
According to Adikoesoemah (1996: 359), break even point analysis used by the
company in order to:
a. evaluating the profit objectives of the company as a whole,
b. Present cost and profit data to top management, which is necessary for making
decisions and formulating policies,
c. Replace the bulky report system with a graphic that is easy to read and understand.
In using BEP analysis, there are several objectives to be achieved, namely:
a. design product specifications;
b. determine the selling price per unit;
c. determine the minimum amount of production or sales to avoid losses;
d. maximize production quantities;
e. plan for desired profit.
C. BEP Point Changes and Their Impact:
In principle, in the break even point, there are several assumptions that must be met,
namely that the selling price per unit does not change during the analyzed period, as well as
variable costs per unit and fixed costs. If these assumptions are not met, the break even point
will change. These changes include the following.
1. Change in Selling Price Per Unit
Changes in the selling price per unit will affect the size of the break even point. If
the selling price per unit increases while costs do not change, it will lower the break
even point. Vice versa, if the selling price decreases, it will increase the break even
point.
2. Change in Variable Cost Per Unit
Changes in variable costs will also change the position of the break even point,
i.e. if variable costs rise, it will increase the break even point and if they fall, it will
decrease the break even point.
3. Change in Fixed Costs
Similarly, changes in fixed costs will change the BEP position to be greater if
fixed costs increase and will decrease if fixed costs decrease.
4. Changes in Sales Mix Composition
Basically, the BEP assumption states that if the company only produces one
product and produces more than two products, there should be no change in the
composition of the sales mix. The role of sales mix shows the balance of sales between
the various products produced. If there is a change in the sales mix, it will cause a
change in the total BEP.
According to Mulyadi (1993: 259), the impact of changes can occur from several
factors in break even point analysis, these factors include the following.
a. Any changes in variable costs will result in changes in contribution margin and break-
even.
b. A change in selling price will result in a change in contribution margin and break-even.
c. The contribution profit figure will only be affected by changes in variable costs and
selling prices.
d. A change in fixed costs results in a change in breakeven, but does not affect
contribution profit.
e. A combined change in fixed costs and variable costs in the same direction will cause a
sharp change in break-even.
D. Pricing Strategy and Management:
1. Definition and Purpose of Pricing
Price is an important part of marketing a product. Price is one of the four marketing
mixes (4P = product, price, place, promotion).
In another sense, price is an exchange rate of goods or services expressed in monetary
units. In this context, price is one of the determinants of the company's success because price
determines the amount of profit that the company will get from selling its products, both in
the form of goods and services.
According to Alex S. Nitisemito (1991: 55), price is defined as the value of a good or
service measured by a certain amount of money, which is based on the value that a person or
company is willing to release goods or services owned to other parties. Stanton (1984)
defines price as the value expressed in dollars and cents or other monetary mediums as a
medium of exchange.
The objectives in pricing are as follows.
a.
Profit-oriented
Every business always chooses pricing that aims to generate the most profit. The
amount of competition makes it difficult for a business to ensure the price that can
generate the most profit.
As a solution, businesses use the profit target approach, which is the amount of
profit that corresponds to the profit target. Volume-oriented, pricing in such a way as
to achieve a certain level of sales volume, sales value or market share.
b.
Volume-Oriented
Volume-oriented pricing aims to set prices to achieve certain sales volume or
market share targets. The price is lower than profit-oriented pricing.
c.
Price Stability Oriented
The goal of price stability orientation is to maintain stability between the price
of a business's products and the prices of its competitors.
In general, the role of prices is often ignored by some entrepreneurs, especially
entrepreneurs who view the role of prices as passive.
Based on this thinking, entrepreneurs think that the most important things are product
form, communication planning, and distribution methods. This is true because the role of
price will reflect the quality, service, type of distribution and the intended consumers.
2. Price in The Positioning Strategy
Managers in making pricing decisions are in need of coordination with decisions for the
entire positioning components. The components known in the price position strategy include
the following.
a.
Product Strategy
Pricing decisions also require analysis of the product mix, brand strategy, product
quality, and product usability. All four are needed to determine that these factors are
considered very influential in pricing.
b.
Distribution Strategy
The distribution strategy serves to state that the factors that influence pricing
decisions are channel type, channel prowess, and channel arrangement.
c.
Responsibility for Pricing Decisions
This approach states that inter-functional participation is considered important in
pricing. That is because pricing will have an impact on all business functions, namely
operations, engineering, finance, and marketing.
3. Pricing Situations
Pricing strategy requires constant monitoring. That's because changes in external
conditions, competitive actions, and opportunities to bypass competition coexist with pricing
actions.
Therefore, some types of situations require pricing action, including:
a.
decide how to price value position for new or similar products;
b.
evaluating the need for the price rules imposed on the abandoned product, further
becomes the product life cycle;
c.
change the positioning strategy that will be used to modify the prevailing pricing
strategy;
d.
decide on strategies to respond to pressure from competitive threats.
4. The Roles of Pricing
Price in its position has shown various roles in the marketing program. It is a sign or
indicator for buyers, as a tool in competition, developing a financial appearance, and as a
substitute for other marketing program functions. Here are the signs or indicators.
a.
Signal to the Buyer
Price has been instrumental in offering a quick and direct way of communicating
with buyers. Prices are visible to buyers and provide a basis for comparison between
brands. Price is used to position the brand as a high quality product or as a substitute to
continue competition with other brands.
b.
Instrument of Competition
Price can offer one way to quickly eliminate competitors, or another possibility
for a company to leave the competition outright. In general, pricing strategies are
always linked to competition, with companies using low, high, or general prices.
c.
Improving Financial Performance
Since the use of prices and costs to determine financial performance, pricing
strategies require estimates to forecast the effect on financial performance company.
The most important thing is the benefits and costs involved in choosing a pricing
strategy.
d.
Marketing Program Considerations
Price can substitute for trial sales, advertising, and sales promotion. Alternatively,
price can also be used to reinforce promotional activities in a marketing program.
In reality, the role of pricing often depends on how the other components are used
in the marketing program.
5. Pricing Strategy
The key stage in choosing a pricing strategy for a new product or maintaining an
existing product is to determine the pricing objectives to achieve strategy development.
Analyzing the situation in pricing brings in the calculation of demand, costs,
competition, and objective pricing. Based on the analysis of the situation and objective
pricing, a pricing strategy is chosen. The final stages of specific pricing and political
operations are determined by the implementation of the strategy.
Therefore, the strategy models that can be applied include the following.
a.
New Product Pricing Strategy:
The price set for a new product must have a favorable effect on market growth. In
addition, to prevent fierce competition from arising. There are two things to consider in
pricing new products (Tjiptono, 2001: 172), which are as follows.
1) Skimming Pricing
Skimming pricin:g is a strategy that serves to set high prices on new products, and is
complemented by vigorous promotional activities. The goal is to:
a) cater to customers who are not very price-sensitive, while there is no competition;
b) cover the costs of promotion and research through large margins;
c) In case there is a mistake in pricing, it is easier to lower the price than to raise the initial
price.
2) Penetration Pricing:
Penetration pricing is a strategy that serves to set low prices at the beginning of
production. It needs to be implemented with the aim of gaining a large market share while
deterring the entry of competitors. With low pricing, companies achieve economies of scale
and lower per-unit costs. This strategy has a long-term perspective, where short-term profits
are sacrificed to achieve a sustainable competitive advantage.
In its implementation, there are four forms of prices that use penetration pricing
strategies, which are as follows.
a) A restrained price position means a unit price set with the aim of maintaining a certain
price level during a period of inflation.
b) Elimination price is a pricing activity at a certain level. This pricing aims to keep
certain competitors out of the competition.
c) Promotion price is a price position set at a low value, but the same quality. This step
needs to be done with the aim of promoting certain products.
d) Keep-out price is a specific pricing decision. It is necessary in order to prevent
competitors from entering the market.
b.
Pricing Strategy for Established Products:
In its development, a company must always review the pricing strategy of its products
that are already on the market. According to Tjiptono (2001: 174), several factors cause it to
be necessary, namely:
1) changes in the market environment, such as a large competitor lowering prices;
2) shifts in demand, such as changes in consumer tastes.
Therefore, the strategy needed in reviewing the pricing that has been carried out, the
company actually uses three alternatives, namely as follows.
1) Maintaining prices. This strategy is implemented with the aim of maintaining a position
in the market and to improve a good image in the community.
2) Lowering prices. This strategy is difficult to implement because the company must
have a large financial capability, while the consequences that must be borne by the
company receive a small level of profit margin.
3) Raising prices. Companies carry out a policy of raising prices with the aim of
maintaining profitability in periods of inflation and to segment certain markets.
c.
Price Adjustment Strategy:
Companies usually adjust the base price so that it can account for various customer
differences and changing situations.
According to Kotler and Armstrong (2008: 3), there are six strategies for price
adjustment, including the following.
1) Discount Pricing and Price Reductions:
In general, companies adjust base prices to reward customers, as well as to respond to
certain responses, such as early payment of bills, large volume purchases, and off-season
purchases. Such price adjustments are commonly called discounts and in practice entail price
reductions.
The forms of discounts and/or price reductions are:
a) Cash discount, which means making price reductions to buyers who pay their bills early;
b) Quantity discount, which means making price reductions for buyers who buy in large
quantities;
c) Functional discount, which means reducing the price offered by the seller to members of
the trade channel who perform certain functions, such as selling, storing, and reporting;
d) Seasonal discount, which means reducing prices for buyers who purchase merchandise
or services out of season.
2) Allowance
Price discounts (allowances) are another form of price list reduction. The forms of
discounts are divided into two parts, namely:
a) Trade-in rebates are a form of price reduction given to consumers for exchanging old
goods and buying new goods;
b) Promotional rebates are a form of payment or price reduction in exchange for dealers or
suppliers participating in advertising and sales support programs.
3) Segmented Pricing
In general, companies often make adjustments to the base price to account for
differences in customer types, products, and locations.
In segmented pricing, companies may sell goods or services at two or more prices,
although there are price differences that are not based on cost differences.
4) Psychological Pricing
Psychological pricing is a form of pricing that is oriented towards considering price
psychology and not solely economic pricing.
Another aspect of pricing psychology is reference pricing. Reference price is the price
that sticks in the buyer's mind and is used as a reference when looking at a particular product.
In practice, a reference price can be established by taking note of current prices and
recalling past prices, or reviewing the buying situation.
5) Promotion Pricing
Promotional pricing means temporarily pricing a product below list price or even below
cost. The aim is to increase short-term sales.
6)
Basically, companies need to decide how to set prices for customers located in different
parts of the country or the world. Therefore, there are five geographic pricing strategies,
namely:
a) FOB-origin pricing, meaning that goods are not paid for by the seller, but the customer
pays for shipping from the factory to the destination;
b) Uniform-delivered pricing means that the company sets prices with the same delivery
costs for all customers, regardless of location;
c) Zone pricing, which means that the company establishes two or more zones, all
customers in the same zone pay the same total price, the further away the zone, the
higher the price;
d) Basing-pont pricing means that the seller designates a specific city as the base point
and charges all customers the cost of shipping from that city to the customer's location.
7) International Pricing
In general, the price to be set by a company in a particular country depends on many
factors including economic conditions, the competitive situation, laws and regulations, and
the progress of the wholesale and retail trading system.
