(iv) Limitation of breakeven analysis:
Although breakeven analysis can give a firms an indication of the minimum sales revenue or sales units that are required to cover fixed costs, it is based on a number of assumptions that form the basis for its limitations as they simplify reality.
Sales Mix – this is assumed to be constant. It reality fluctuations in demand caused by changing consumer tastes and demand is likely.
Selling price – this is assumed to be constant regardless of the level of demand. In reality to increase sales volumes a reduction in the selling price is usually required.
Inventory levels – are ignored and assumed to be constant.
Linear cost behaviour – both variable costs and fixed costs are assumed to remain constant regardless of the level of activity. The ignores economies of scale which are likely as production volumes increase and the fact that fixed costs may rise once production exceeds a certain level, for example additional factory space may have to be rented. |
