The two concepts marginal analysis and break even analysis are widely used in management decision making to decide selling prices and to control costs. The key difference between marginal analysis and break even analysis is that marginal analysis calculates the revenue and costs associated with producing additional units whereas break even analysis calculates the number of units that should be produced to cover the fixed cost. Understanding the relationship between variables involved assists in realizing how the changes to the said variables affect the overall performance of the company.
1. Overview and Key Difference
2. What is Marginal Analysis
3. What is Break Even Analysis
4. Side by Side Comparison – Marginal Analysis vs Break Even Analysis
What is Marginal Analysis?
Marginal analysis is the study of the costs and benefits of a small (marginal) change in the production of goods or an additional unit of an input or good. This is an important decision making tool businesses can use to decide how to allocate scarce resources in order to minimize costs and maximize earnings. The effect of marginal analysis is calculated as per below.
Change in Net Benefits = Marginal Revenue – Marginal Cost
Marginal revenue – This is the rise in total revenue of producing additional units
Marginal cost – This is the rise in total cost of producing additional units
E.g. GNL is a shoe manufacturer who produces 60 pairs of shoes at the cost of $55,700. Cost per pair of shoes is $928. The sales price of a pair of shoes is $ 1,500. Thus, the total revenue is $90,000. If GNL produces an additional pair of shoes, the revenue will be $91,500, and the total cost will be $ 57,000.
Marginal revenue = $91,500- $90,000= $1,500
Marginal cost = $57,000-$55700=$1,300
The above results in a change in net benefit of $200 ($1,500-$1,300)
Marginal analysis helps businesses decide whether it is beneficial or not to produce additional units. Increasing the output alone is not advantageous if the selling prices cannot be maintained. Therefore marginal analysis supports the business to identify the optimal level of production.
What is Break Even Analysis?
The break even analysis is one of the most important management accounting concepts that has a widespread use. The main concentration is in calculating the ‘break-even point’, which is the point at which the company does not make a profit or a loss. Calculation of break-even point considers the fixed and variable costs associated with production and the price at which the company wishes to sell the product. Based on the costs and estimated price, the number of units that should be sold in order to ‘break-even’ can be determined. Break-even analysis is also referred to as the CVP analysis (Cost-Volume-Profit analysis).
Calculation of break-even point should be conducted through following steps.
The contribution is the resulting amount after covering fixed costs that contribute towards making a profit. It will be calculated as,
Contribution = Sales Price per Unit – Variable Cost per Unit
Break Even Volume
This is the number of units that should be sold in order to earn sufficient contribution to cover the fixed cost. This is the break-even point in terms of units.
Break-even Volume = Fixed Cost / Contribution per Unit
Contribution to Sales Ratio (C/S ratio)
C/S ratio calculates the amount of contribution a product would earn relative to sales and this is expressed as a percentage or a decimal.
C/S Ratio = Contribution per Unit / Sales Price per Unit
Break Even Revenue
Break even revenue is the revenue where the company will incur neither a profit nor a loss. This is the break-even point in terms of revenue. It will be calculated as,
Break-even Revenue = Fixed Overhead / CS Ratio
E.g. AVN Company is a mobile device manufacturing company which sells a device for $16 after incurring a variable cost of $7. Total fixed cost is $2,500 per week.
Contribution = $16-$7 = $9
Break-even volume = $2,500/9 = 277.78 units
C/S ratio = $9/$16 = 0.56
Break-even revenue = $2,500/0.56 = $4,464.28
AVN will break-even at a sales volume of 277.78 earning a revenue of $ 4,464.28
Uses of Break Even Analysis
- To determine the level of sales required to cover all costs and earn a profit
- To assess how the profitability will alter if the company injects new capital in the form of fixed cost or due to changes in variable costs
- To arrive at a number of short-term decisions relating to sales mix and pricing policy
What is the difference between Marginal Analysis and Break Even Analysis?
Marginal Analysis vs Break Even Analysis
|Marginal analysis calculates the revenue and costs associated with producing additional units.||Break even analysis calculates the number of units that should be produced to cover the fixed cost.|
|Marginal analysis is used to calculate the effect of producing additional units of output.||Break-even analysis is used to calculate the number of units that should be produced to cover fixed cost.|
|Marginal analysis is a relatively simple decision-making tool.||A number of steps are involved in break-even analysis calculation.|
Summary – Marginal Analysis vs Break Even Analysis
While both are widely utilized yardsticks for management decision making, the difference between marginal analysis and break even analysis is distinct in nature. Marginal analysis is specifically useful in evaluating whether or not to accept small orders since it is designed to assess marginal changes to cost and revenue structures. On the other hand, break-even analysis is much suited to evaluate the overall performance and to track changes in operating structures. Effects of both have to be evaluated on a regular basis since several factors can change and influence the outcome.
1. “Break-Even Point & Marginal Revenue.” Chron.com. Chron.com, 19 May 2013. Web. 27 Mar. 2017.
2. “Marginal Analysis in Economics: Definition, Formula & Examples – Video & Lesson Transcript.” Study.com. N.p., n.d. Web. 27 Mar. 2017.
3. Peavler, Rosemary. “Every Business Owner Needs to Know How to Calculate Breakeven Point.” The Balance. N.p., n.d. Web. 27 Mar. 2017.
4. “The Importance of the Breakeven Point.” CEDIA. N.p., n.d. Web. 27 Mar. 2017.
1. “CVP-TC-Sales-PL-BEP” By Nils R. Barth – Self-made in Inkscape. (Public Domain) via Commons Wikimedia