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Capital Budgeting Practices in Corporate

Question:

Discuss about the Capital Budgeting Practices in Corporate.

Answer:

Introduction:

Break even point is a financial process which is used by the companies to measure the margin of safety of the company on the basis of the total revenue and the total units which must be sold in the market to cover all the variable and the fixe cost associated with the production and manufacturing process of that particular product. In the given report, break even analysis has been studied to identify the uses, pros, cons, method, process etc of break even analysis and understand that how could this process be used in an organization to make decisions (Vogel, 2014).     

The process of break even analysis has been measured on the basis of a case study; a case study has been prepared and presented in the report on the basis of the hypothetical data to represent about the process and the uses of breakeven point in an organization. There are various different uses and the methods of the breakeven point which assist the company to enhance the overall operations and the activities of the business. The break even analysis case study has been presented and prepared on the basis of a new technology. The main thing about BEP is to understand about the difference among the revenue and the profit of the company.

The process of the BEP makes it easier for an organization to make decision about the current operations of the company as well as the new investment opportunity of the company. It measures the various related cost of the manufacturing on the basis of the fixed cost, variable cost and the semi variable cost to measure the overall position and the performance of the business.

Break even analysis:

Many of the entrepreneurs and the business owners make mistakes of bringing a service or the product to the market without understanding the concept of the total cost and the prices involved in the process of the services and the goods manufacturing. As an outcome of it, entrepreneurs discover that they could not sell enough of the services and the products in the market to generate the profits (Moyer et al, 2011). Among the various available tools for decision making, break even analysis is most important used tool which is used to make better decision about the production process and the selling units of the company.

This process makes it easy for the entrepreneurs to determine the accuracy of the business that whether the business would be profitable for the company or not. Best of all, this break even analysis tool is used to evaluate each and every product and services of the company and their total profitability in the company. It is one of the simpler methods to analyze that how many profits and the services are required to sell by the company in order to reach over a point where no loss could be faced by the company (Madhura, 2011).

An entrepreneur and the financial manager of a business are required to keep the following points in the mind while using the break even analysis in the company:

  • Every business has definite fixed cost which is required to be paid by the business at the end of each month whether the production and the sales of the business have taken place or not.
  • Each business has some variable cost which is incurred in the business when a product is manufactured or sold in the market by the company.
  • There is always some variable cost which gown up and down on the basis of the business activity (Fridson & Alvarez, 2011).

After the evaluation on all the cost of the company, costs are connected together to make a particular product which is brining into the market in order to sale. The profit contribution from selling that particular product is divided into fixed cost to evaluate that how many units must be sold by the company to reach over a breakeven point (Chandra, 2011).

A break even analysis has some advantages and the disadvantages which is required to know for the entrepreneurs to measure the performance of the company and the decision making process of the business. The advantages of the break even analysis are as follows:

  • It is quite easier to create the breakeven analysis.
  • Break even analysis is quick to create which explains that entrepreneurs and the owners of the business could take immediate actions to reduce the cost and enhance the overall sales of the company.
  • Break even analysis allows the business owners to forecast the variation in the total sales of the business which would make impact on the profits, revenue and the costs. And how these variations in the sales impact on the cost and the prices of the product (Chowdhury & Chowdhury, 2010).
  • The break even analysis helps the business owners to lend the money from the bank.
  • This tool also helps the business owners to influence the significant decisions of a business which might require making on the products.
  • This tool also helps the business owners to understand the level of the risk which is involved in the business (Verma, Gupta & Batra, 2009).
  • It also helps the business owners to understand the viability of business propositions as well as it also helps the owners to attract the investors.

In addition, there are some disadvantages of the break even analysis which has been discussed below:

  • The tool of business analysis assumes that the variable cost of the business always rises steadily and it is not important for variable cost to rise steadily.
  • Break even analysis could be conducted for a single product or the service. It could not be applied on more products at a single time (Verma, Gupta & Batra, 2009).
  • If the data of the break even analysis is wrong than the total outcome will also be wrong which would lead to the wrong decision.
  • Break even analysis always assumes that the product has already been sold and there are no wastage left in the business.

On the basis of the evaluation on the advantages and disadvantages of the business, it has been measured that the business owners of the business are required to evaluate all the factors briefly and make a decision accordingly.

Conduct a break even analysis:

A break even analysis is a crucial part of the great business plan. On the basis of the evaluation, it has been recognized that the business plan could be helpful for the business owners even before planning and making a blue print of the business. It explains that the break even analysis is very helpful for the business from the initial level to the long run of the business (Brijlal, 2008). Following is a case study which briefs about the break even analysis and its conduction process:

ABC is a public limited company in the Australian market. The company is looking for the expansion and thus the company has planned to diversify the market into the new industry. A deal has been offered to the company by a supplier which explains that if the ABC limited enters into the manufacturing of electric items than the operating cost of the business would be $ 10,000 per month. The supplier has explored the market and on the basis of the evaluation on the market, supplier has proposed that the each unit of the product could be sold in $ 1000 in the market. The cost evaluation study has been done and it has been measured that the cost of the each product would be $ 800 at the time of the production, sell the product and the delivering the product.

The supplier has also explained that the demand of the product would be increased day by day in the market. As the technology involvement in the project is quite advanced which would make the customers attract towards the product and make them loyal towards the business. It has also been briefed that the overall performance of the business would be better and this project would make the profitability level of the company higher.

It has been studied that the break even points explains about the total number of units which is required to sell by the company in order to get the enough sales revenue through which the entire fixed and variable cost of the business could be covered (Maroyi & van de r Poll, 2012). The breakeven point in units could be measured on the basis of the total operating cost of the business which is also known as the fixed cost of the business and the contribution margin per unit . The contribution margin per unit could be calculated on the basis of the sales price per unit and the variable cost which is associated with the product per unit (Brigham & Houston, 2012).

On the basis of the case study, it has been found that the total operating cost of the new business plan of the company would be $ 10000. It has also been measured that the sales price of the product is $ 1000 and the variable cost involved in the project is $ 800. It leads to the discussion that the contribution per unit of the project would be $ 200 which has been received after deducting the variable cost from the total sales of the project.

Further, it has been measured on the basis of the case study that the fixed cost of the project is $ 10,000. On the basis of the contribution margin per unit and the fixed cost of the project, it has been measured that the breakeven point of the business in units is 50 units. It explains that it is requisite for the business to sell at least 50 units each month to cover all the expenses and reach over a limit from where the margin of safety level of the product starts (Bierman & Smidt, 2012). The business must sell approximately 2 units of the product each day so that the requirements and the common goal of the business could be met.

The calculations and the study on the case briefs that the ABC limited is required to sell 50 units in each of the month to begin to generate revenues from the project. Conducting a better and an accurate analysis of the break even require a cautious investigation and a better study on the prices and the cost of the business. a business planner is required to know that what is the product or the service cost in the organization to deliver a final product and the service to the customer as well as what is the total price which would be charged against the product and services of the project (Higgins, 2012). Business planner and the financial manager of the business are required to add and deduct all the miscellaneous expenses of the business which is involved to run the business on the basis of their nature (Truong, Partington & Peat, 2008).

To get started, a business planner is required to analyze every services and the product of the business which is produced and sold on a regular basis. Planner must prepare a list of all the products and the services starting from the largest to the lowest volume seller. In addition, the planner is required to measure the total sales price of each of the unit and on the basis of that, calculate the total cost of each of the item of the project (Gapenski & Reiter, 2008). Analyze the total percentage of the profit or the return which has been earned by the business planner an owner from selling each unit of the project.

It is very important for a business to organize and maintain the each of the services and product of the business on the basis of priority in order to manage the contribution and the profitability level of the business (Murdock et al, 2010). The analysis should be done on each of the service and product of the business to get an accurate result. The conduction of break even analysis starts by determining the:

  • Most profitable service and the product of the company
  • Sales volume of each of the product
  • Total profit associated with each of the product after reducing the entire direct and indirect expenses of the project (Comas et al, 2013)
  • Total profit contribution of each of the products and service of the business.

Many business owners make a decision about the continuation of the business or discontinue the business or a particular product or the services after conducting this analysis in the business (Xia & Luo, 2014). It is immediately seen by them that whether it would be beneficial or profitable for the company to invest the money and the time in the business to sell and produce something better in the business or not.        

According to the market condition, the demand of a particular product in the market gets changes. Such as, if the economy or the environment of a particular area changes than the demand of the woollen products also get change. Thus, a product which was quite popular in the market becomes no longer successful (Scarborough, 2016). It explains to the owner that it is the time when the invested amount in the company must be divested and the money will be invested into the new project. It is the time for the business owners to offer a new product and the service in the market which is easier to sell in the market and the demand of the product is also higher so that it could be sold in the higher prices which would lead to the great profits to the company (Tsorakidis et al, 2011).

According to the case which has been described above, it has been found that the production manager of the business and the main executives have to be eagerly conscious about the sales  level and the level of the sales revenue to cover all the variable and fixed cost at all the times. That is why they continuously try to make few changes in the elements in the formula to reduce the total number of units which is required to product the products and enhances the overall profitability of the company (Dersch et al, 2009). Such as, in the given case, if the manager of the ABC limited decides to enhance the sales price of the electric product by $ 100 than it would make huge changes into the total number of units which is required by the business to cover all the fixed cost and the variable cost which would be included additionally in the production process of the company (Morano & Tajani, 2013).

Lower variable cost of the business is equal to the great profits per unit as well as it also reduces the number of units which is required to produce and sells in the market to cover all the fixed and variable expenses of the business. It has also been measured that the outsourcing policy could also make an impact on the cost structure of the business. In addition, the most important concept of the breakeven point is to recognize the margin of safety of the business (Dietrich et al, 2013). Margin of safety is the difference between the total number of units which are required to meet the profit gaol and the required units which should be sold to cover all the expenses of the business.

In the discussed case, ABC limited has to produce and sell around 50 units each month to cover all the operating cost and variable cost of the company. If the sales of the business enhances to 60 units then the company would be able to make extra profits from the business (berry, 2010). This 10 unit spread is the margin of safety. The sales revenue from these 10 units could be afford by the company to lose but still the company would be in such a position that the entire expenses of the company would be covered.

Conclusion:

On the basis of the study on the break even analysis and the decision process on the basis of the break even analysis, it has been found that the break even analysis is a better tool to measure the changes and the performance of the business. Breakeven point and the analysis process is a financial process which is used by the companies to measure the margin of safety of the company on the basis of the total revenue and the total units which must be sold in the market to cover all the variable and the fixe cost associated with the production and manufacturing process of that particular product.

In the report the break even analysis has been studied along with the uses, pros, cons, method, process etc of break even analysis in order to understand that how could this process be used in an organization to make decisions. And on the basis of the evaluation, it has been measured that the breakeven analysis is among the most used tool in the business which helps the product manager, financial managers and other executives of the business to make a better decision about the performance of the business.  

The process of break even analysis has been measured on the basis of a case study. The case study has been prepared and presented in the report on the basis of the hypothetical data to represent about the process and the uses of breakeven point in an organization. The evaluation study on the breakeven point analysis explains that an organization should apply this technique at the starting of the business so that it could be identified that whether the business and the particular product would be able to make the profits or not. The break even analysis case study has been presented and prepared on the basis of a new technology. The main thing about BEP is to understand about the difference among the revenue and the profit of the company.

References:

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Brijlal, P. (2008). The use of capital budgeting techniques in businesses: A perspective from the Western Cape.

Chandra, P. (2011). Financial management. Tata McGraw-Hill Education.

Chowdhury, A., & Chowdhury, S. P. (2010). Impact of capital structure on firm's value: Evidence from Bangladesh. Business & Economic Horizons, 3(3).

Comans, T. A., Martin-Khan, M., Gray, L. C., & Scuffham, P. A. (2013). A break-even analysis of delivering a memory clinic by videoconferencing. Journal of telemedicine and telecare, 19(7), 393-396.

Dersch, J., Morin, G., Eck, M., & Häberle, A. (2009). Comparison of linear Fresnel and parabolic trough collector systems-system analysis to determine break even costs of linear Fresnel collectors.

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