Break-Even and Sensitivity Analysis for Credit Officers
How far can sales fall before the loan is in trouble? Break-even and sensitivity analysis answer that with numbers.
Every project report shows a comfortable base case. Break-even and sensitivity analysis ask the banker's question: how far can things go wrong before the borrower stops making money, or stops meeting the instalment?
Break-even finds the level of sales at which profit is zero. Sensitivity analysis changes one assumption at a time, such as price, cost or volume, and shows what happens to profit, DSCR or IRR. Both rest on splitting costs into fixed (do not move with output, like rent, depreciation and interest on loans) and variable (move with output, like raw material).
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The Worked Unit
| Item | Value |
|---|---|
| Selling price per unit | ₹500 |
| Variable cost per unit | ₹300 |
| Contribution per unit (500 - 300) | ₹200 |
| P/V ratio (200 ÷ 500) | 40% |
| Fixed costs per year (includes depreciation ₹10 lakh and term loan interest ₹6 lakh) | ₹40 lakh |
| Installed capacity | 50,000 units |
| Projected sales (70% of capacity) | 35,000 units |
| Term loan instalment per year | ₹15 lakh |
Break-Even, Cash Break-Even and Margin of Safety
- 1
Break-even in units
Fixed costs ÷ contribution per unit = 40,00,000 ÷ 200 = 20,000 units.
- 2
Break-even in sales value
Fixed costs ÷ P/V ratio = 40,00,000 ÷ 0.40 = ₹1 crore (20,000 units × ₹500, the same answer).
- 3
Break-even as % of capacity
20,000 ÷ 50,000 = 40%. The lower this is, the safer the project: it starts making profit at a low level of output.
- 4
Cash break-even
Depreciation is a fixed cost but not a cash cost. Leave it out: (40 - 10) lakh ÷ 200 = 15,000 units. Above this, operations generate cash even while the books still show a loss.
- 5
Cash break-even including the instalment
To also cover the ₹15 lakh instalment from operations (before tax): (30 + 15) lakh ÷ 200 = 22,500 units, which is 45% of capacity.
- 6
Margin of safety
(Projected sales - break-even sales) ÷ projected sales = (35,000 - 20,000) ÷ 35,000 = 42.9%. Sales can fall by about 43% before the unit makes a loss.
- 7
Profit at projected sales
35,000 × 200 = ₹70 lakh contribution, less ₹40 lakh fixed costs = ₹30 lakh profit before tax. Check: margin of safety in value × P/V ratio = 15,000 × 500 × 0.40 = ₹30 lakh.
Sensitivity: One Change at a Time
Tax assumed at 25% for the illustration. DSCR = (PAT + depreciation + interest) ÷ (interest + instalment).
Base case
Contribution per unit
₹200
Profit before tax (₹ lakh)
30.0
DSCR
1.83
Break-even units
20,000
Margin of safety
42.9%
Volume down 10% (31,500 units)
Contribution per unit
₹200
Profit before tax (₹ lakh)
23.0
DSCR
1.58
Break-even units
20,000
Margin of safety
36.5%
Variable cost up 10% (₹330)
Contribution per unit
₹170
Profit before tax (₹ lakh)
19.5
DSCR
1.46
Break-even units
23,529
Margin of safety
32.8%
Selling price down 10% (₹450)
Contribution per unit
₹150
Profit before tax (₹ lakh)
12.5
DSCR
1.21
Break-even units
26,667
Margin of safety
23.8%
| Case | Contribution per unit | Profit before tax (₹ lakh) | DSCR | Break-even units | Margin of safety |
|---|---|---|---|---|---|
| Base case | ₹200 | 30.0 | 1.83 | 20,000 | 42.9% |
| Volume down 10% (31,500 units) | ₹200 | 23.0 | 1.58 | 20,000 | 36.5% |
| Variable cost up 10% (₹330) | ₹170 | 19.5 | 1.46 | 23,529 | 32.8% |
| Selling price down 10% (₹450) | ₹150 | 12.5 | 1.21 | 26,667 | 23.8% |
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What the Table Tells the Banker
The same 10% shock hurts very differently. A 10% fall in volume costs ₹7 lakh of profit. A 10% rise in variable cost costs ₹10.5 lakh. A 10% fall in price costs ₹17.5 lakh, because every rupee of price lost comes straight out of contribution on every unit sold. Price is the variable this project is most sensitive to, so that is the assumption the credit officer should test hardest against market data. DSCR stays above 1 in every case, but the price case drops it to 1.21, well below the 1.5 to 2 range often quoted for term loans.
How Sensitivity Analysis Is Done
- check_circlePick the assumptions you are least sure of and those with the biggest weight in the cash flow: selling price, main raw material cost, capacity utilisation, project cost, and delay in start of production.
- check_circleChange one at a time by a plausible amount, holding the rest at base case, and recompute profit, DSCR or IRR.
- check_circleThen run a combined adverse scenario, several variables at once, to see the worst case.
- check_circleA project that keeps a healthy DSCR under such stress is far easier to sanction. One that falls below 1 on a single 10% shock needs a different structure: more promoter equity, a longer repayment, or a lower loan.
How the IIBF Exam Tests This
- check_circleBEP in units (fixed cost ÷ contribution per unit) and in value (fixed cost ÷ P/V ratio).
- check_circleCash BEP: remove depreciation and other non-cash costs from fixed cost.
- check_circleMargin of safety, and the link profit = margin of safety × P/V ratio.
- check_circleWhich change hurts most: a price cut versus the same percentage rise in cost or fall in volume.
- check_circleConcept: sensitivity analysis changes one variable at a time; scenario analysis changes several together.
FAQs
What is the formula for break-even point?expand_more
Break-even in units = total fixed cost ÷ contribution per unit. Break-even in sales value = total fixed cost ÷ P/V ratio, where P/V ratio is contribution ÷ sales.
What is cash break-even point?expand_more
The output at which operations generate just enough cash to meet cash fixed costs. It is found by removing non-cash costs such as depreciation from fixed costs before dividing by contribution per unit, so it is always lower than the accounting break-even.
What is margin of safety?expand_more
The gap between projected sales and break-even sales, usually as a percentage of projected sales. A 42.9% margin of safety means sales can fall by that much before the business makes a loss.
What is sensitivity analysis in project appraisal?expand_more
Changing one key assumption at a time, such as selling price or raw material cost, and measuring the effect on profit, DSCR or IRR. It shows which assumption the project's viability depends on most.
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