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1. Managerial Economics 19MBA12
Adhichunchanagiri University, BGSIT, BG Nagara Page 1
UNIT 6: PROFITS (6 HOURS)
Profits: Determinants of Short-Term & Long Term Profits, Measurement of Profit. Break Even
Analysis – Meaning, Assumptions, Determination of BEA, Limitations, Uses of BEA in
Managerial decisions.
PROFIT:
INTRODUCTION:
One of the basic objectives of an organisation is to earn profit. Sufficient amount of profit is
necessary for future growth and expansion of an organisation. It also ensures payment of
attractive dividend to shareholder.
In economic terms, Profit is a reward to an entrepreneur for his effort. It is a reward for capital
invested by an entrepreneur. Profit is calculated after subtracting the costs of maintaining land,
labour & capital from earnings. It is also known as net income.
What is left after paying contractual rent to land, wages to workers & interest to capital borrowed
is called profits. The profits are non-contractual income & therefore they may be negative or
positive.
Business profits are, therefore, specially contingent upon the successful management of risk.
Modern industry is faced with a number of uncertainties. The entrepreneur receives a reward for
combining the factors of the production to meet economic needs of the people faced with various
uncertainties. He gets profits because he selects the risks & manages them skillfully.
MEANING AND DEFINITION:
The share of income that goes to the organiser or the entrepreneur is known as profit. It is a
residual income after payment of all factors of production.
In the words of Prof.Knight, “profit is a reward for uncertainty bearing”.
According to Hawley, “profit is a reward for risk bearing”.
DETERMINANTS OF PROFIT:
 Excess of income over costs.
 Reward for risk management and better management
 For uncertainty bearing

2. Managerial Economics 19MBA12
Adhichunchanagiri University, BGSIT, BG Nagara Page 2
 Due to innovation
 Due to increase in the price level
 Due to imperfect competition and monopoly
 Due to correct estimation of future
 DETERMINANTS OF SHORT TERM PROFIT:
 Rate of growth of the economy.
 Market structure.
 Demand situation
 Expenditure on promotional efforts
 DETERMINANTS OF LONG TERM PROFIT:
 Introduction of new product
 Changing in product design
BREAK EVEN ANALYSIS:
Break even analysis which is also known as profit contribution analysis , is an important
analytical technique used to study , the relationship between total costs, total revenue and total
profits and losses over the whole range of stipulated study.
It is also called cost volume profit analysis.
It has been said that: the break-even point is that point of activity (sales volume) where total
revenues and total costs are equal, it is the point of zero profit”
In broader sense it refers to the study of relationship between costs, volume and profit at
different levels of sales or production.
According to Charles T. Horngren:” the break-even point of activity is where total revenue and
total expense are equal. It is a point of zero profit and zero loss.

3. Managerial Economics 19MBA12
Adhichunchanagiri University, BGSIT, BG Nagara Page 3
BREAKEVEN GRAPH:
ASSUMPTIONS OF BEA:
 All elements of cost .i.e. production, administration and selling distribution can be segregated
into fixed and variable components.
 Variable cost remains constant per unit of output irrespective of the level of output and thus
fluctuates directly in proportion to changes in the volume of output.
 Fixed cost remains constant at all volumes of output.
 Selling price per unit remains unchanged or constant at all levels of output.
 Volume of production is the only factor that influences cost.
 There will be no change in the general price level.
 There is only one product or in case of multi products, the sales mix remains unchanged
 There is synchronization between production and sales.
DETERMINATION/TECHNIQUES OF BEA:
The break even analysis deals with the prices, costs structure and the sales volume and identifies
the profit figure with one or other combination of these variables. The key elements in the break
even analysis are selling prices, sales volume, variable cost per unit, total fixed cost and sales

4. Managerial Economics 19MBA12
Adhichunchanagiri University, BGSIT, BG Nagara Page 4
mix ( if the firm is dealing with more than one product at a time). There are 3 basic techniques
for determination of break-even analysis. These are:
BREAK EVEN POINT:
 It is a point where sales revenue equals the costs to make and sell the product and no profit or
loss is reported
 Break-even point is the level of sales at which profit is zero. At break-even point , sales are
equal to fixed cost plus variable.
 Break even sales= fixed cost + variable cost
LIMITATIONS OF BREAK EVEN ANALYSIS:
 Need for system and accounting techniques: the company must maintain good accounting
system and proper marginal accounting techniques and procedures.
 Static in nature: it is static in character and is more useful in stable and slow moving situation
rather than volatile, erratic and widely changing ones.
 Costs: costs in a particular period may not be caused entirely by the output in that period.
 Difficult to handle selling cost: it is difficult to handle selling cost in break even analysis is
because the changes in selling costs are a cause and not a result of changes in the output and
sales
 Maintain several price levels: calculation should be made of several price levels because it is
not possible to sell any quantity at one price.
 Not suitable for long run- break even analysis is not effective for long range use and should
be restricted to short run only. It should be limited to the budget period of the firm.
 Linear relationship- the cost revenue volume relationship is linear only over a narrow range
of output.
 Limited to few products- it should be limited to few products and not too many products and
departments.
 Assumptions- break even analysis assumes that profits are a function of output ignoring that
those are also caused by technological changes, improved management, changes in the scale
of fixed factors of output.

5. Managerial Economics 19MBA12
Adhichunchanagiri University, BGSIT, BG Nagara Page 5
USES OF BEA IN MANAGERIAL DECISION:
 Safety margin: the safety margin refers to the extent to which the management can afford to
decline the sales before it starts incurring losses.
The break even chart also helps the management to know at a glance, the profits generated at
various levels of sales. The safety margin is the total sales in the excess of sales at break-even
point.
 Volume needed to attain the targeted profit: break even analysis is useful for determining the
volumes of sales necessary to achieve the targeted profit.
 To expand capacity or not: the management is naturally and invariably interested in
increasing the production capacity through the installation of additional equipment. The
break even analysis will help the management to examine the various implications of the
proposal because installation of new plant may involve a change in fixed costs, variable costs
price and demand of the commodity.
 The effect of alternative prices: it is established fact that the break-even point becomes lower
with every increase in price, but in actual practice it is not necessary possible that the profit
potentials may be realized by the firm.