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Jan 25 2013

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Limitations of Break Even Analysis

Break even analysis is done before a product or service to be offered to the market. It provides an overall idea about how many units of a product to manufacture, what will be the price of a product and which advertising channel will be used for marketing purpose. Every manufacturing organization conducts break even analysis at the time of launching any product to the market in order to analyze overall economic effect of the new product. As break even analysis is conducted through predetermined assumptions, there are some limitations behind the break even analysis and these limitations are as follows:-

Limitations of Break Even Analysis 

Selling price is considered as constant: When break even analysis is conducted, manufacturing companies are assuming that the selling price of the product will be constant. But in today’s highly competitive business environment, the selling price of a product may need to be adjusted as per the market demand in order to stay competitive in the market. Selling price of goods and services may be constant when the goods and services are provided by the Government. This is a first and foremost limitation of break even analysis.

Production cost can be accurately divided into fixed and variable: Production cost cannot be divided into fixed and variable element because costs are linear within the relevant range and it changes when the number of units of a product changes. Fixed cost is assumed to be constant up to the relevant range irrespective of the production level which may often lead to wrong estimation at the time of using the break even analysis.

In multi product companies the sales mix is constant: Sales mix can never be constant, as competition is going on single product basis in the market. In today’s global competitive business environment, the choice of customers are changing at an accelerated way and therefore manufacturing companies are getting momentum customers choice competition to stay competitive in the market. For example, Apple Inc. has iPhone and iPad and they have many versions in order to offer superior customer buying experience. People also frequently change their linkages and therefore the sales mix is always shifted.

In manufacturing companies, inventories do not change: Inventories are always changing with the ongoing production system. This is another great limitation of break even analysis which is made through predetermined assumptions. It is really impossible to keep inventory unchanged and continue production. In manufacturing organizations, inventories always change due to continue its production process smoothly.

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