Breakeven point is a very crucial factor in any business due to the importance of its applications. To begin with, breakeven analysis is used to determine the profits that can be earned from a product. It is important to note that the ultimate aim of any firm is to make profits through selling of products. Therefore, the firm should know the number of units in any product that should be sold to cover all cost. Most importantly, breakeven analysis is useful in determining whether there is any chance of making profits at all for a given commodity. Secondly, breakeven analysis is useful when determining unit price of a commodity (Horngren, 2012). By setting unit price as a variable in the decision making equation, the most effective price can be determined. A price that is able to quickly earn profits with the minimal cost of production and marketing is the best unit price of a commodity. In Addition, breakeven analysis can be used as a decision making tool especially in choosing financial strategy of a firm. Using breakeven analysis, a firm can be able to forecast future costs and profits which is vital in decision making process (Cafferky & Wentworth, 2010).
On the other hand, consideration should be made between relevant and irrelevant costs when making any decision. It should be noted that for a cost to qualify for consideration during decision making, it should meet a number of conditions. Firstly, the cost should be a future cost because current decisions have no effect on past costs. Secondly, the costs should be directly affected by the decision made. This means that the decision should have the ability of either increasing or decreasing the cost. Lastly, the cost should have an effect on the cash flow of the firm. A cost that meets the above conditions is considered as a relevant cost. It is important to note that irrelevant costs will not in any way be affected by any decision made. In this regard, using irrelevant costs to make decisions will lead to wrong decisions which will not be applicable (Hansen & Mowen, 2010). Moreover, elimination of irrelevant costs from equations will save time and ease the decision making process. Take an example of a firm that has already purchased raw materials ready for production of a given commodity. Assume that before the production commences there is an increase in other costs of production (Vanderbeck, 2012). In making decision as whether to go on with the production or not, the firm should not include the already incurred cost of acquiring raw materials. This is because this will erroneously double the cost and thus lead to wrong decisions.
Mixed costs category has both fixed and variable costs. While the fixed costs component are incurred whether production takes place or not, variable costs component are incurred depending on the units produced. As a result, when making decisions, only variable costs should be taken into consideration (Horngren, 2012). Consequently, distinction should be made between the part of mixed costs that is fixed and the one that is variable. It is also important to note that the distinction is vital in determining marginal costs, preparation of budget estimates and controlling of expenses. However, it is sometimes difficult to determine the fixed costs and the variable costs (Drury, 2006). Though there are various methods of classifying mixed costs into fixed costs and variable costs, they just approximate thus making it difficult to know exactly the quantity of costs that are fixed or variable.
Cafferky, M. & Wentworth, J. (2010). Breakeven Analysis: The Definitive Guide to Cost-Volume-Profit Analysis. New York: Business Expert Press.
Drury, C. (2006). Cost and Management Accounting: An Introduction. Stanford: Cengage Learning.
Hansen, D. R. & Mowen, M. M. (2010). Cornerstones of Cost Accounting. Stanford: Cengage Learning.
Horngren, C. T. (2012). Cost Accounting: A Managerial Emphasis, 13/e. Upper Saddle River: Pearson Education.
Vanderbeck, E. J. (2012). Principles of Cost Accounting, 16th ed. Stanford: Cengage Learning.