case study of break even analysis

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Break-even analysis, a break-even analysis helps determine the point at which total revenues equal total costs.

A break-even analysis helps to determine the number of  product   units that need to be sold for a business to be profitable,  knowing the price and the cost of the product. It is crucial to understand the concept of  fixed and variable costs  to correctly calculate the break-even point during your case interview , but also in your daily work as a consultant. If the fixed costs are greater than zero, then it is important to have a positive contribution margin per unit (i.e. price>variable costs) to reach a break-even point at all.

A break-even analysis helps illustrate the relationship between profits, revenues, and costs

Because of the  positive contribution margin, the slope of the revenue line is steeper than the slope of the total costs line . Therefore, revenue per unit is higher than cost per unit. If there were no fixed costs, then obviously the business would be profitable from the beginning. In the example shown above, the costs involved when zero units are sold are the fixed costs only. To cover these fixed costs,  the business needs to  sell a certain number of units  to reach this  break-even point  or cover the fixed costs. 

High break-even points usually suggest that a business could benefit from economies of scale

A detailed break-even analysis can provide some insight regarding the economics of a certain project or the entire industry. Imagine you come across a business that has a high break-even point, since the business needs to sell a lot of products to become profitable (e.g., Intel). This scenario is usually due to  large fixed costs (so-called asset-heavy industries) which need to be covered by high product sales. In such situations, economies of scale play a major role: The more units you sell, the more you cover the fixed costs. In addition, due to the experience/learning curve, you tend to have fewer variable costs and therefore more control over prices . Also, high fixed costs are a serious entry barrier for new competitors (see Porter's Five Forces for more details).

Apply the break-even analysis in weak profitability situations

For instance, your client is operating at increasing losses even though revenues have increased. You find that the issue is increased costs because of a  newly opened factory . The  additional fixed costs are still higher  than the gain in revenues, leading to losses. 

In this case, we can start by hypothesizing the need to increase revenues  to fix profitability. In this scenario, it would make sense to check the break-even number of units sold before recommending increased marketing efforts. For a break-even analysis, you need to have information such as fixed costs, variable costs, and price.

Required data

• Yearly fixed costs: $50m
• Average variable cost/product: $1000
• Average price/product: $1500

Calculation

• Profit/product: $1,500 - $1,000 = $500
• $500 * x units = $50m
• x units = 100,000

As a result, the factory needs to produce and sell 100,000 units. Make sure to check its feasibility and if infeasible, your advice could be to  divest the new factory .

Key takeaways

• At the break-even point, a business has no net gain/loss .
• To determine the break-even point, you will need a  breakdown of the costs and revenues  of the product.

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Hacking the Case Interview

A breakeven analysis is a common quantitative calculation you’ll perform in case interviews. You may need to conduct a breakeven analysis when you are determining whether a company should enter a new market, launch a new product , or acquire a company.

A breakeven analysis helps a company to determine whether or not they should make a particular business decision. All companies have a goal of being profitable from the decisions that they make.

By looking at the circumstances that need to be true in order for a company to recoup its investment costs, a company can see how likely it is that they will be profitable.

If the conditions for breaking even are favorable, a company may decide to pursue an investment. If the conditions for breaking even are unfavorable, the company may decide to pursue something else.

In this article, we’ll cover:

• The breakeven analysis formula for case interviews
• How to interpret breakeven in case interviews
• Breakeven analysis examples in case interviews
• Breakeven analysis case interview tips

If you’re looking for a step-by-step shortcut to learn case interviews quickly, enroll in our case interview course . These insider strategies from a former Bain interviewer helped 30,000+ land consulting offers while saving hundreds of hours of prep time.

Breakeven Analysis Formula for Case Interviews

By definition, breakeven occurs when a company earns as much money as it has spent. In other words, breakeven occurs when the revenue generated from operations has grown to the point that the company has recouped all of its costs.

To get the formula for breakeven, we set profit equal to zero. This is the same thing as setting revenue equal to costs.

Profit = Revenue – Costs

$0 = Revenue - Costs

Revenue = Costs

We can further breakdown revenue as the product of price and quantity of units sold. We can also breakdown costs into variable costs and fixed costs. Remember that variable costs is equal to the quantity of units sold times the variable cost per unit.

Quantity * Price = (Quantity * Variable Cost) + Fixed Costs

We can simplify this formula to get our formula for breakeven analysis.

Fixed Costs = (Price – Variable Cost) * Quantity

This is the only formula you need to know to solve any breakeven problem in a case interview. You should memorize this formula so that you will not need to derive it from scratch during a case interview.

However, if you understand the intuitive meaning behind this formula, as explained in the next section, you won’t even need to memorize it.

How to Interpret Breakeven in Case Interviews

To understand the breakeven formula better, let’s go through each of the terms.

Fixed costs are costs that the company has to incur regardless of how many units of product are produced. Fixed costs include:

Variable costs are costs that increase as the number of units produced increases. They are costs associated with directly producing a unit of product. Variable costs include:  

• Raw materials
• Direct labor

Price is the amount the product is being sold for. In other words, it is the amount of money the company receives for each unit sold.

Finally, quantity is the number of units of product that are sold.

Here is how to understand the formula intuitively in your case interviews.

For each product sold, the company makes an amount of profit equal to the difference between the product’s price and variable cost. If you multiply this by the quantity of units sold, this is the total profit the company makes.

However, the company has fixed costs that it has paid for or needs to pay for. Therefore, the profit made from selling product has to at least equal fixed costs in order for the company to actually be profitable.

If you can understand the concept of breakeven from this perspective, you should be able to immediately recall the breakeven formula in any case interview situation.

Breakeven Analysis Examples in Case Interviews

The breakeven analysis formula has four different terms. When given a breakeven analysis problem in case interview, you’ll typically know three of these terms and be asked to solve for the fourth term that is unknown.

Therefore, there are four different types of questions you could be asked.

Breakeven Analysis Example #1

You operate a lemonade stand that sells a cup of lemonade for $4. The cost to produce a cup of lemonade is $1. To legally operate a lemonade stand, you had to purchase a permit for $600. How many cups of lemonade do you need to sell to break even?

$600 = ($4 - $1) * Quantity

$600 = $3 * Quantity

Quantity = 200

You will need to sell 200 cups of lemonade.

Breakeven Analysis Example #2  

Your company produces and sells widgets. Each widget costs $500 to produce. You have $100,0000 in fixed costs and expect to be able to sell 1,000 widgets. What minimum price do you need to set for your widgets to break even?

$100,000 = (Price - $500) * 1,000

$100 = Price - $500

Price = $600

You need to price your widgets for at least $600.

Breakeven Analysis Example #3

A pharmaceutical company is considering investing money to research a new drug. They believe they can sell 10,000 units of this drug for $201 each over the course of the drug’s lifetime. The cost to produce each drug is $1. How much does the company need to keep research costs under in order to generate a profit?

Fixed Costs = ($201 - $1) * 10,000

Fixed Costs = $200 * 10,000

Fixed Costs = $2,000,000

The company needs to keep fixed costs under $2,000,000.

Breakeven Analysis Example #4

Your company is a roofing tile distributor. You purchase roofing tiles from suppliers and sell them to retailers for a profit. Your annual fixed costs are $100,000. Each tile that you sell is priced at $1 and you sell ten million tiles a year. What is the maximum price per tile that you can purchase tiles for and still break even?

$100,000 = ($1 – Variable Cost) * 10,000,000

$0.01 = $1 – Variable Cost

Variable Cost = $0.99

You can purchase the tiles for $0.99 each at most.

Breakeven Analysis Case Interview Tips

During your case interview, follow these tips to ensure that your breakeven analysis proceeds smoothly.

1. Make sure to include all costs 

When doing breakeven analysis, it is important that you include all of the potential costs involved in managing and operating the business. Leaving out even a single cost element will change your answer.

2. Distinguish between variable costs and fixed costs

Whether a particular cost is a variable cost or a fixed cost can drastically change your answer. Therefore, ensure that you are correctly identifying each cost as either a variable cost or fixed cost.

The simplest way to assess this is to determine whether the cost element would increase if an additional unit is produced. If it does increase, then it is likely a variable cost. If it does not increase, then it is probably a fixed cost.

3. Check that price is greater than variable costs

It is impossible for a company to break even if its variable cost per unit is greater than the price that it charges for its product. Therefore, if you observe that price is less than variable costs, know that there is no way for the company to break even.

4. Talk the interviewer through each of your steps

Whenever you are doing math during a case interview, you want to make it as easy as possible for the interviewer to follow what you are doing. So, before you begin doing any calculations, walk the interviewer through your approach.

Start by explaining the breakeven formula that you are going to be using. Then, as you perform each calculation, talk through exactly what you are doing out loud.

This is beneficial for two reasons. One, you’ll be less likely to make math mistakes if you are talking through the calculations out loud. Two, it will be easier for the interviewer to give you hints or help you out if they know exactly what you are doing.

5. State the implications of your answer 

Once you finish calculating your answer, don’t just stop there. Remember, the purpose of a breakeven analysis is to help a company determine whether it should make a particular investment.

Based on the answer that you calculated, do you think the company can realistically achieve the conditions to at least break even? If so, you could hypothesize that the company should make the investment. If not, you should consider what the company could do to increase the likelihood that it will be profitable.

Stating the implications of your breakeven analysis demonstrates that you are a proactive problem solver. This is a quality that separates outstanding case interview candidates from average candidates.

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A Quick Guide to Breakeven Analysis

It’s a simple calculation, but do you know how to use it?

In a world of Excel spreadsheets and online tools, we take a lot of calculations for granted. Take breakeven analysis. You’ve probably heard of it. Maybe even used the term before, or said: “At what point do we break even?” But because you may not entirely understand the math — and because understanding the formula can only deepen your understanding of the concept — here’s a closer look at how the concept works in reality.

• Amy Gallo is a contributing editor at Harvard Business Review, cohost of the Women at Work podcast , and the author of two books: Getting Along: How to Work with Anyone (Even Difficult People) and the HBR Guide to Dealing with Conflict . She writes and speaks about workplace dynamics. Watch her TEDx talk on conflict and follow her on LinkedIn . amyegallo

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Case Study: Understanding Break-Even Analysis

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Break Even Analysis allows you to evaluate if your business is making a profit or not, so is integral in not only running a business, but also in directing the future of the business.

Break-Even Analysis Case Study: The Achar Company

The Achar Company is a small company started in 2020. They produce and distribute 10 kg buckets of achar. The Achar Company makes delicious affordable achar from the scratch using fresh and quality ingredient and delivering at a small fee according to orders across Gauteng.

The Selling Price per unit is R350 per 10 kg bucket of achar and the variable costs per bucket are R100, and that makes the gross profit to be R250 per bucket, but the fixed costs are R15250 per month.

In conclusion, we can see that this business is making enough profit only to cover the monthly fixed costs therefore the business is not making profit nor making a loss.

As the business owner, they can also identify other ideas in order to make profit. Such as:  

• Increase the selling price per unit.
• Increase production units per month (make more Buckets of achar per months).
• Add another achar making machine,
• Rent a cheaper place
• Restructure or retrenchment
• Reduce salaries
• Review cheaper insurances etc.

Dr Dennis Mark Laxton

DBA, MBL, MBA, BTech Academic Team Leader and Senior Lecturer Regenesys Business School

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Break-Even Analysis Explained - Full Guide With Examples

Did you know that 30% of operating small businesses are losing money? Running your own business is trickier than it sounds. You have to plan ahead carefully to break-even or be profitable in the long run.

Building your own small business is one of the most exciting, challenging, and fun things you can do in this generation.

To start and sustain a small business it is important to know financial terms and metrics like net sales, income statement and most importantly break-even point .

Performing break-even analysis is a crucial activity for making important business decisions and to be profitable in business.

So how do you do it? That is what we will go through in this article. Some of the key takeaways for you when you finish this guide would be:

• Understand what break-even point is
• Know why it is important
• Learn how to calculate break-even point
• Know how to do break-even analysis
• Understand the limitations of break-even analysis

So, if you are tired of your nine-to-five and want to start your own business, or are already living your dream, read on.

What is Break-Even Point?

Small businesses that succeeds are the ones that focus on business planning to cross the break-even point, and turn profitable .

In a small business, a  break-even point is a point at which total revenue equals total costs or expenses. At this point, there is no profit or loss — in other words, you 'break-even'.

Break-even as a term is used widely, from stock and options trading to corporate budgeting as a margin of safety measure.

On the other hand, break-even analysis lets you predict, or forecast your break-even point. This allows you to course your chart towards profitability.

Managers typically use break-even analysis to set a price to understand the economic impact of various price and sales volume calculations.

The total profit at the break-even point is zero. It is only possible for a small business to pass the break-even point when the dollar value of sales is greater than the fixed + variable cost per unit.

Every business must develop a break-even point calculation for their company. This will give visibility into the number of units to sell, or the sales revenue they need, to cover their variable and fixed costs.

Importance of Break-Even Analysis for Your Small Business

A business could be bringing in a lot of money; however, it could still be making a loss. Knowing the break-even point helps decide prices, set sales targets, and prepare a business plan.

The break-even point calculation is an essential tool to analyze critical profit drivers of your business, including sales volume, average production costs, and, as mentioned earlier, the average sales price. Using and understanding the break-even point, you can measure

• how profitable is your present product line
• how far sales drop before you start to make a loss
• how many units you need to sell before you make a profit
• how decreasing or increasing price and volume of product will affect profits
• how much of an increase in price or volume of sales you will need to meet the rise in fixed cost

How to Calculate Break-Even Point

There are multiple ways to calculate your break-even point.

Calculate Break-even Point based on Units

One way to calculate the break-even point is to determine the number of units to be produced for transitioning from loss to profit.

For this method, simply use the formula below:

Break-Even Point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)

Fixed costs are those that do not change no matter how many units are sold. Don't worry, we will explain with examples below. Revenue is the income, or dollars made by selling one unit.

Variable costs include cost of goods sold, or the acquisition cost. This may include the purchase cost and other additional costs like labor and freight costs.

Calculate Break-Even Point by Sales Dollar - Contribution Margin Method

Divide the fixed costs by the contribution margin. The contribution margin is determined by subtracting the variable costs from the price of a product. This amount is then used to cover the fixed costs.

Break-Even Point (sales dollars) = Fixed Costs ÷ Contribution Margin

Contribution Margin = Price of Product – Variable Costs

Let’s take a deeper look at the some common terms we have encountered so far:

• Fixed costs: Fixed costs are not affected by the number of items sold, such as rent paid for storefronts or production facilities, office furniture, computer units, and software. Fixed costs also include payment for services like design, marketing, public relations, and advertising.
• Contribution margin:   Is calculated by subtracting the unit variable costs from its selling price. So if you’re selling a unit for $100 and the cost of materials is $30, then the contribution margin is $70. This $70 is then used to cover the fixed costs, and if there is any money left after that, it’s your net profit.
• Contribution margin ratio: is calculated by dividing your fixed costs from your contribution margin. It is expressed as a percentage. Using the contribution margin, you can determine what you need to do to break-even, like cutting fixed costs or raising your prices.
• Profit earned following your break-even: When your sales equal your fixed and variable costs, you have reached the break-even point. At this point, the company will report a net profit or loss of $0. The sales beyond this point contribute to your net profit.

Small Business Example for Calculating Break-even Point

To show how break-even works, let’s take the hypothetical example of a high-end dressmaker. Let's assume she must incur a fixed cost of $45,000 to produce and sell a dress.

These costs might cover the software and materials needed to design the dress and be sure it meets the requirement of the brand, the fee paid to a designer to design the look and feel of the dress, and the development of promotional materials used to advertise the dress.

These costs are fixed as they do not change per the number of dresses sold.

The variable costs would include the materials used to make each dress — embellishment’s for $30, the fabric for the body for $20, inner lining for $10 — and the labor required to assemble the dress, which amounted to one and a half hours for a worker earning $50 per hour.

Thus, the unit variable costs to make a single dress is $110 ($60 in materials and $50 in labor). If she sells the dress for $150, she’ll make a unit margin of $40.

Given the $40 unit margin she’ll receive for each dress sold, she will cover her $45,500 total fixed cost will be covered if she sells:

Break-Even Point (Units) = $45,000 ÷ $40 = 1,125 Units

You can see per the formula , on the right-hand side, that the Break-even is 1,125 dresses or units

In other words, if this dressmaker sells 1,125 units of this particular dress, then she will fully recover the $45,000 in fixed costs she invested in production and selling. If she sells fewer than 1,125 units, she will lose money. And if she sells more than 1,125 units, she will turn a profit. That’s the break-even point.

What if we change the price?

Suppose our dressmaker is worried about the current demand for dresses and has concerns about her firm’s sales and marketing capabilities, calling into question her ability to sell 1,125 units at a price of $150. What would be the effect of increasing the price to $200?

This would increase the unit margin to $90.Then the number of units to be sold would decline to 500 units. With this information, the dressmaker could assess whether she was better off trying to sell 1,125 dresses at $150 or 500 dresses at $200, and priced accordingly.

What if we want to make an investment and increase the fixed costs?

Break-even analysis also can be used to assess how sales volume would need to change to justify other potential investments. For instance, consider the possibility of keeping the price at $150, but having a celebrity endorse the dress (think Madonna!) for a fee of $20,000.

This would be worthwhile if the dressmaker believed that the endorsement would result in total sales of $66,000 (the original fixed cost plus the $20,000 for Ms. Madonna).

With the Fixed Costs at $66,000 we see, it would only be worthwhile if the dressmaker believed that the endorsement would result in total sales of 1,650 units.

In other words, if the endorsement led to incremental sales of 525 dress units, the endorsement would break-even. If it led to incremental sales of greater than 525 dresses, it would increase profits.

What if we change the variable cost of producing a good?

Break-even also can be used to examine the impact of a potential change to the variable cost of producing a good.

Imagine that our dressmaker could switch from using a rather plain $20 fabric for the dress to a higher-end $40 fabric, thereby increasing the variable cost of the dress from $110 to $130 and decreasing the unit margin from $40 to $20. How much would your sales need to increase to compensate for the extra cost?

Suppose the Variable Cost is $130 (and the Fixed Cost is $45,000 – our dressmaker can’t afford to have nice fabric plus get Ms. Madonna). It would make better sense to switch to the nicer fabric if the dressmaker thought it would result in sales of 2,250 units, an additional 1125 dresses, which is double the number of initial sale numbers.

You likely aren’t a dressmaker or able to get a celebrity endorsement from Ms. Madonna, but you can use break-even analysis to understand how the various changes of your product, from revenue, costs, sales, impact your small business’s profitability .

What Are the Benefits of Doing a Break-even Analysis?

Smart Pricing : Finding your break-even point will help you price your products better. A lot of effort and understanding goes into effective pricing, but knowing how it will affect your profitability is just as important. You need to make sure you can pay all your bills.

Cover Fixed Costs : When most people think about pricing, they think about how much their product costs to create. Those are considered variable costs. You will still need to cover your fixed costs like insurance or web development fees. Doing a break-even analysis helps you do that.

Avoid Missing Expenses : When you do a break-even analysis, you have to lay out all your financial commitments to figure out your break-even point. It’s easy to forget about expenses when you’re thinking through a business idea.  This will limit the number of surprises down the road.

Setting Revenue Targets : After completing a break-even analysis, you know exactly how much you need to sell to be profitable. This will help you set better sales goals for you and your team.

Decision Making : Usually, business decisions are based on emotion. How you feel is important, but it’s not enough. Successful entrepreneurs make their decisions based on facts. It will be a lot easier to decide when you’ve put in the work and have useful data in front of you.

Manage Financial Strain : Doing a break-even analysis will help you avoid failures and limit the financial toll that bad decisions can have on your business. Instead, you can be realistic about the potential outcomes by being aware of the risks and knowing when to avoid a business idea.

Business Funding : For any funding or investment, a break-even analysis is a key component of any business plan. You have to prove your plan is viable. It’s usually a requirement if you want to take on investors or other debt to fund your business.

When to Use Break-even Analysis

Starting a new business.

If you’re thinking about a small online business or e-commerce, a break-even analysis is a must. Not only does it help you decide if your business idea is viable, but it makes you research and be realistic about costs, as well as think through your pricing strategy.

Creating a new product

Especially for a small business, you should still do a break-even analysis before starting or adding on a new product in case that product is going to add to your expenses. There will be a need to work out the variable costs related to your new product and set prices before you start selling.

Adding a new sales channel

If you add a new sales channel, your costs will change. Let's say you have been selling online, and you’re thinking about opening an offline store; you’ll want to make sure you at least break-even with the brick and mortar costs added in. Adding additional marketing channels or expanding social media spends usually increases daily expenses. These costs need to be part of your break-even analysis.

Changing the business model

Let's say you are thinking about changing your business model; for example, switching from buying inventory to doing drop shipping or vice-versa, you should do a break-even analysis. Your costs might vary significantly, and this will help you figure out if your prices need to change too.

Limitations of Break-even Analysis

• The Break-even analysis focuses mostly on the supply-side (i.e., costs only) analysis. It doesn't tell us what sales are actually likely to be for the product at various prices.
• It assumes that fixed costs are constant. However, an increase in the scale of production is likely to lead to an increase in fixed costs.
• It assumes average variable costs are constant per unit of output, per the range of the number of sales
• It assumes that the number of goods produced is equal to the number of goods sold. It believes that there is no change in the number of goods held in inventory at the beginning of the period and the number of goods held in inventory at the end of the period
• In multi-product companies,  the relative proportions of each product sold and produced are fixed or constant.

So that's a wrap. Hope you found this article interesting and informative. Feel free to subscribe to our blog to get updates on awesome new content we publish for small business owners.

Key Takeaways

Break-even analysis is infinitely valuable as it sets the framework for pricing structures, operations, hiring employees, and obtaining future financial support.

• You can identify how much, or how many, you have to sell  to be profitable.
• Identify costs inside your business that should be alleviated or eliminated.

Remember, any break-even analysis is only as strong as its underlying assumptions.

Like many forecasting metrics, break-even point is subject to it's limitations; however it can be a powerful and simple tool to provide a small business owner with an idea of what their sales need to be in order to start being profitable as quickly as possible.

Lastly, please understand that break-even analysis is not a predictor of demand .

If you go to market with the wrong product or the wrong price, it may be tough to ever hit the break-even point. To avoid this, make sure you have done the groundwork before setting up your business.

Head over to our small business guide on setting up a new business if you want to know more.

Want to calculate break even point quickly? Use our handy break-even point calculator.

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Article • 6 min read

Break-Even Analysis

Determining when a product becomes profitable.

By the Mind Tools Content Team

In business, your ultimate objective is to make money.

So, when you launch a new product or purchase a new piece of equipment, how do you know whether a potential investment will at least cover the costs associated with it?

You could simply make a wish and hope it all works out – or you can evaluate the project more formally to see if it makes financial sense. One way of doing this is to complete a Break-Even Analysis.

This determines the break-even point – the level of output at which the revenues generated by a project equal costs. At the break-even point, you don't make or lose money. Once you pass break-even, you make money; below break-even, you lose it.

Using a Break-Even Analysis, you can answer questions like:

• What are the projected profits and losses at any given output level?
• At what minimum sales level do you avoid making a loss?
• Do your sales projections for a new product exceed break-even?
• If you drop a product, will your break-even improve?
• How will raising or lowering prices affect your profitability?
• If costs increase, what is the effect on your break-even position?
• How does investing in facility improvements affect your break-even point?

Calculating the Break-Even Point

Determining the break-even point involves a simple mathematical equation. You reach break-even at the point where total costs (TC) equal total revenues (TR), or

Total costs have fixed and variable components:

• Fixed costs (FC) remain the same, regardless of your output. Rent, insurance, and base salaries are examples of fixed costs.
• Variable costs (VC) change with the number of units produced or sold. Examples are materials, sales commissions, and direct labor costs. Therefore, total variable costs (TVC) equal the variable costs multiplied by the number of units, or TVC = n x VC, where n is the number of units.
• Total costs equal total fixed costs plus total variable costs: TC = FC + (n x VC).

You can see how these costs vary with the number of units sold in figure 1, below:

Total revenue is the price charged per unit multiplied by the number of units produced or sold: TR = n x P, where P equals the unit price.

Again, you can see the line for Total Revenue in figure 1, with break-even occurring where the TR line crosses the TC line.

You can calculate the break-even point by expanding the break-even equation:

TC = TR FC + (n x VC) = n x P

Solving for n gives you the number of units you need to break even:

n = FC/(P – VC)

If you have a specific profit target, you can use the break-even equation to calculate the number of units you must sell to achieve that target:

n x P = FC + (n x VC) + Profit n = (FC + Profit)/(P – VC)

A Break-Even Example

Let's imagine that you're considering launching a new product. Market research has shown that customers will pay $115 for it, and your sales team is confident that they can sell at least 500 units per month. The equipment you'll need to produce the product costs $900,000 and this will be spread over three years, giving you a fixed cost of $25,000 per month. You need to decide if the product is financially viable.

To calculate the break-even point, use this equation:

n = FC/(P – VC) n = 25,000/(115 – 50) n = 384.6

The break-even point is 385 units per month. This is below the minimum sales volume that the sales team thinks they can achieve, so the product has a good chance of making money.

Break-Even Analysis can also be useful in thinking about pricing. For example, how much would the break-even point increase if you reduced the price to $105? This should increase the sales volume, but would that compensate enough for the lower price? Using the break-even point, you can manipulate a variety of costs and revenue variables to understand the effects of various scenarios.

Limitations of Break-Even Analysis

A Break-Even Analysis is best used as a preliminary planning tool. In our example, there are many other issues to consider. What is the opportunity cost of spending $900,000 on the equipment as a capital expense, as opposed to investing the money in something else? Would another product give a better Return on Investment (RoI)?

Break-Even Analysis is also very restrictive in what it includes in the equation. Cost and revenue calculations can be much more complex than those considered in a Break-Even Analysis. Material costs and other costs can change dramatically, and it's not always clear which fixed costs should be included. For example, what portion of executive salaries should you use? Break-Even Analysis also doesn't consider cash flow or how the proposed project might affect economies of scale , nor does it take into account the value of money as it varies with time.

For these reasons and many others, Break-Even Analysis is most often used in the early stages of thinking about a decision. From there, you can decide whether further analysis is needed.

Break-even is the point at which the costs associated with production equal the revenue generated.

To use Break-Even Analysis effectively, you should have a reasonable understanding of the costs involved in your operations.

When it's used as a general decision-making tool, Break-Even Analysis can highlight projects that have a good chance of contributing to profits and those that don't. It's not the tool to use for your final decision, but it can be useful for the early planning stages.

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What Is Break-Even Analysis?

Break-even point formula.

• Calculating BEP and Contribution Margin

Who Calculates the BEP?

Why break-even analysis matters, the bottom line.

• Investing Basics

Break-Even Analysis: Formula and Calculation

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).

Break-even analysis compares income from sales to the fixed costs of doing business. Five components of break-even analysis include fixed costs, variable costs, revenue, contribution margin, and break-even point (BEP). When companies calculate the BEP, they identify the amount of sales required to cover all fixed costs to begin generating a profit. The break-even point formula can help find the BEP in units or sales dollars.

Key Takeaways:

• Using the break-even point formula, businesses can determine how many units or dollars of sales cover the fixed and variable production costs.
• The break-even point (BEP) is considered a measure of the margin of safety.
• Break-even analysis is used broadly, from stock and options trading to corporate budgeting for various projects.

Investopedia / Paige McLaughlin

Break-even analysis involves a calculation of the break-even point (BEP) . The break-even point formula divides the total fixed production costs by the price per individual unit, less the variable cost per unit.

BEP = Fixed Costs / (Price Per Unit - Variable Cost Per Unit)

Break-even analysis looks at the fixed costs relative to the profit earned by each additional unit produced and sold. A firm with lower fixed costs will have a lower break-even point of sale and $0 of fixed costs will automatically have broken even with the sale of the first product, assuming variable costs do not exceed sales revenue. Fixed costs remain the same regardless of how many units are sold. Examples of fixed and variable costs include:

Calculating the Break-Even Point and Contribution Margin

Break-even analysis and the BEP formula can provide firms with a product's contribution margin. The contribution margin is the difference between the selling price of the product and its variable costs. For example, if an item sells for $100, with fixed costs of $25 per unit, and variable costs of $60 per unit, the contribution margin is $40 ($100 - $60). This $40 reflects the revenue collected to cover the remaining fixed costs, which are excluded when figuring the contribution margin.

Contribution Margin = Item Price - Variable Cost Per Unit

To find the total units required to break even, divide the total fixed costs by the unit contribution margin. Assume total fixed costs are $20,000. With a contribution margin of $40 above, the break-even point is 500 units ($20,000 divided by $40). Upon selling 500 units, the payment of all fixed costs is complete, and the company will report a net profit or loss of $0.

BEP (Units) = Total Fixed Costs / Contribution Margin

To calculate the break-even point in sales dollars, divide the total fixed costs by the contribution margin ratio. The contribution margin ratio is the contribution margin per unit divided by the sale price.

Contribution Margin Ratio = Contribution Margin Per Unit / Item Price

BEP (Sales Dollars) = Total Fixed Costs / Contribution Margin Ratio

The contribution margin ratio is 40% ($40 contribution margin per item divided by $100 sale price per item). The break-even point in sales dollars is $50,000 ($20,000 total fixed costs divided by 40%).

In accounting, the margin of safety is the difference between actual sales and break-even sales. Managers utilize the margin of safety to know how much sales can decrease before the company or project becomes unprofitable.

• Entrepreneurs
• Financial Analysts
• Stock and Option Traders
• Government Agencies

Although investors are not interested in an individual company's break-even analysis on their production, they may use the calculation to determine at what price they will break even on a trade or investment. The calculation is useful when trading in or creating a strategy to buy options or a fixed-income security product.

• Pricing : Businesses get a comprehensible perspective on their cost structure with a break-even analysis, setting prices for their products that cover their fixed and variable costs and provide a reasonable profit margin.
• Decision-Making : When it comes to new products and services, operational expansion, or increased production, businesses can chart their profit to sales volume and use break-even analysis to help them make informed decisions surrounding those activities.
• Cost Reduction : Break-even analysis helps businesses find areas to reduce costs to increase profitability.
• Performance Metric: Break-even analysis is a financial performance tool that helps businesses ascertain where they are in achieving their goals.

What Are Some Limitations of Break-Even Analysis?

Break-even analysis assumes that the fixed and variable costs remain constant over time. Costs may change due to factors such as inflation, changes in technology, or changes in market conditions. It also assumes that there is a linear relationship between costs and production. Break-even analysis ignores external factors such as competition, market demand, and changes in consumer preferences.

What Are the Components of Break-Even Analysis?

There are five components of break-even analysis including fixed costs, variable costs, revenue, contribution margin, and the break-even point (BEP).

Why Is the Contribution Margin Important in Break-Even Analysis?

The contribution margin represents the revenue required to cover a business' fixed costs and contribute to its profit. Through the contribution margin calculation, a business can determine the break-even point and where it can begin earning a profit.

How Do Businesses Use the Break-Even Point in Break-Even Analysis?

The break-even point (BEP) helps businesses with pricing decisions, sales forecasting, cost management, and growth strategies. A business would not use break-even to measure its repayment of debt or how long that repayment will take to complete.

Break-even analysis is a tool used by businesses and stock and option traders. Break-even analysis is essential in determining the minimum sales volume required to cover total costs and break even. It helps businesses choose pricing strategies, and manage costs and operations. In stock and options trading, break-even analysis helps find the minimum price movements required to cover trading costs and make a profit. Traders can use break-even analysis to set realistic profit targets, manage risk, and make informed trading decisions.

U.S. Small Business Administration. " Break-Even Point ."

Professor Rosemary Nurre, College of San Mateo. " Accounting 131: Chapter 6, Cost-Volume-Profit Relationships ."

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7.2 Breakeven Analysis

The  break-even point  is the dollar amount (total sales dollars) or production level (total units produced) at which the company has recovered all variable and fixed costs. In other words, no profit or loss occurs at break-even because Total Cost = Total Revenue.  Figure 7.15  illustrates the components of the break-even point:

The basic theory illustrated in  Figure 7.15  is that, because of the existence of fixed costs in most production processes, in the first stages of production and subsequent sale of the products, the company will realize a loss. For example, assume that in an extreme case the company has fixed costs of $20,000, a sales price of $400 per unit and variable costs of $250 per unit, and it sells no units. It would realize a loss of $20,000 (the fixed costs) since it recognized no revenue or variable costs. This loss explains why the company’s cost graph recognized costs (in this example, $20,000) even though there were no sales. If it subsequently sells units, the loss would be reduced by $150 (the contribution margin) for each unit sold. This relationship will be continued until we reach the break-even point, where total revenue equals total costs. Once we reach the break-even point for each unit sold the company will realize an increase in profits of $150.

For each additional unit sold, the loss typically is lessened until it reaches the break-even point. At this stage, the company is theoretically realizing neither a profit nor a loss. After the next sale beyond the break-even point, the company will begin to make a profit, and the profit will continue to increase as more units are sold. While there are exceptions and complications that could be incorporated, these are the general guidelines for break-even analysis.

As you can imagine, the concept of the break-even point applies to every business endeavor—manufacturing, retail, and service. Because of its universal applicability, it is a critical concept to managers, business owners, and accountants. When a company first starts out, it is important for the owners to know when their sales will be sufficient to cover all of their fixed costs and begin to generate a profit for the business. Larger companies may look at the break-even point when investing in new machinery, plants, or equipment in order to predict how long it will take for their sales volume to cover new or additional fixed costs. Since the break-even point represents that point where the company is neither losing nor making money, managers need to make decisions that will help the company reach and  exceed this point as quickly as possible. No business can operate for very long below break-even. Eventually the company will suffer losses so great that they are forced to close their doors.

To illustrate the concept of break-even, we will return to Hicks Manufacturing and look at the Blue Jay birdbath they manufacture and sell.

Sales Where Operating Income Is $0

Hicks Manufacturing is interested in finding out the point at which they break even selling their Blue Jay Model birdbath. They will break even when the operating income is $0. The operating income is determined by subtracting the total variable and fixed costs from the sales revenue generated by an enterprise. In other words, the managers at Hicks want to know how many Blue Jay birdbaths they will need to sell in order to cover their fixed expenses and break even. Information on this product is:

In order to find their break-even point, we will use the contribution margin for the Blue Jay and determine how many contribution margins we need in order to cover the fixed expenses, as shown in the formula in  Figure 7.17 .

Applying this to Hicks calculates as:

What this tells us is that Hicks must sell 225 Blue Jay Model birdbaths in order to cover their fixed expenses. In other words, they will not begin to show a profit until they sell the 226 th  unit. This is illustrated in their contribution margin income statement.

The break-even point for Hicks Manufacturing at a sales volume of $22,500 (225 units) is shown graphically in  Figure 7.19 .

As you can see, when Hicks sells 225 Blue Jay Model birdbaths, they will make no profit, but will not suffer a loss because all of their fixed expenses are covered. However, what happens when they do not sell 225 units? If that happens, their operating income is negative.

Sales Where Operating Income Is Negative

In a recent month, local flooding caused Hicks to close for several days, reducing the number of units they could ship and sell from 225 units to 175 units. The information in  Figure 7.20  reflects this drop in sales.

At 175 units ($17,500 in sales), Hicks does not generate enough sales revenue to cover their fixed expenses and they suffer a loss of $4,000. They did not reach the break-even point of 225 units.

Sales Where Operating Income Is Positive

What happens when Hicks has a busy month and sells 300 Blue Jay birdbaths? We have already established that the contribution margin from 225 units will put them at break-even. When sales exceed the break-even point the unit contribution margin from the additional units will go toward profit. This is reflected on their income statement.

Again, looking at the graph for break-even ( Figure 7.23 ), you will see that their sales have moved them beyond the point where total revenue is equal to total cost and into the profit area of the graph.

Hicks Manufacturing can use the information from these different scenarios to inform many of their decisions about operations, such as sales goals.

However, using the contribution margin per unit is not the only way to determine a break-even point. Recall that we were able to determine a contribution margin expressed in dollars by finding the contribution margin ratio. We can apply that contribution margin ratio to the break-even analysis to determine the break-even point in dollars. For example, we know that Hicks had $18,000 in fixed costs and a contribution margin ratio of 80% for the Blue Jay model. We will use this ratio ( Figure 7.24 ) to calculate the break-even point in dollars.

Applying the formula to Hicks gives this calculation:

Hicks Manufacturing will have to generate $22,500 in monthly sales in order to cover all of their fixed costs. In order for us to verify that Hicks’ break-even point is $22,500 (or 225 units) we will look again at the contribution margin income statement at break-even:

By knowing at what level sales are sufficient to cover fixed expenses is critical, but companies want to be able to make a profit and can use this break-even analysis to help them.

Examples of the Effects of Variable and Fixed Costs in Determining the Break-Even Point

Companies typically do not want to simply break even, as they are in business to make a profit. Break-even analysis also can help companies determine the level of sales (in dollars or in units) that is needed to make a desired profit. The process for factoring a desired level of profit into a break-even analysis is to add the desired level of profit to the fixed costs and then calculate a new break-even point. We know that Hicks Manufacturing breaks even at 225 Blue Jay birdbaths, but what if they have a target profit for the month of July? They can simply add that target to their fixed costs. By calculating a target profit, they will produce and (hopefully) sell enough bird baths to cover both fixed costs and the target profit.

If Hicks wants to earn $16,000 in profit in the month of May, we can calculate their new break-even point as follows:

We have already established that the $18,000 in fixed costs is covered at the 225 units mark, so an additional 200 units will cover the desired profit (200 units × $80 per unit contribution margin = $16,000). Alternatively, we can calculate this in terms of dollars by using the contribution margin ratio.

As done previously, we can confirm this calculation using the contribution margin income statement:

Note that the example calculations ignored income taxes, which implies we were finding target operating income. However, companies may want to determine what level of sales would generate a desired after-tax profit. To find the break-even point at a desired after-tax profit, we simply need to convert the desired after-tax profit to the desired pre-tax profit, also referred to as operating income, and then follow through as in the example. Suppose Hicks wants to earn $24,000 after-taxes, what level of sales (units and dollars) would be needed to meet that goal? First, the after-tax profit needs to be converted to a pre-tax desired profit:

If the tax rate for Hicks is 40%, then the $24,000 after-tax profit is equal to a pre-tax profit of $40,000:

The tax rate indicates the amount of tax expense that will result from any profits and 1 – tax rate indicates the amount remaining after taking out tax expense. The concept is similar to buying an item on sale. If an item costs $80 and is on sale for 40% off, then the amount being paid for the item is 60% of the sale price, or $48 ($80 × 60%). Another way to find this involves two steps. First find the discount ($80 × 40% = $32) and then subtract the discount from the sales price ($80 – $32 = $48).

Taxes and profit work in a similar fashion. If we know the profit before tax is $100,000 and the tax rate is 30%, then tax expenses are $100,000 × 30% = $30,000. This means the after-tax income is $100,000 – $30,000 = $70,000. However, in most break-even situations, as well as other decision-making areas, the desired after-tax profit is known, and the pre-tax profit must be determined by dividing the after-tax profit by 1 – tax rate.

To demonstrate the combination of both a profit and the after-tax effects and subsequent calculations, let’s return to the Hicks Manufacturing example. Let’s assume that we want to calculate the target volume in units and revenue that Hicks must sell to generate an after-tax return of $24,000, assuming the same fixed costs of $18,000.

Since we earlier determined $24,000 after-tax equals $40,000 before-tax if the tax rate is 40%, we simply use the break-even at a desired profit formula to determine the target sales.

This calculation demonstrates that Hicks would need to sell 725 units at $100 a unit to generate $72,500 in sales to earn $24,000 in after-tax profits.

Alternatively, target sales in sales dollars could have been calculated using the contribution margin ratio:

Once again, the contribution margin income statement proves the sales and profit relationships.

Thus, to calculate break-even point at a particular after-tax income, the only additional step is to convert after-tax income to pre-tax income prior to utilizing the break-even formula. It is good to understand the impact of taxes on break-even analysis as companies will often want to plan based on the after-tax effects of a decision as the after-tax portion of income is the only part of income that will be available for future use.

Application of Break-Even Concepts for a Service Organization

Because break-even analysis is applicable to any business enterprise, we can apply these same principles to a service organization. For example, Marshall & Hirito is a mid-sized accounting firm that provides a wide range of accounting services to its clients but relies heavily on personal income tax preparation for much of its revenue. They have analyzed the cost to the firm associated with preparing these returns. They have determined the following cost structure for the preparation of a standard 1040A Individual Income Tax Return:

They have fixed costs of $14,000 per month associated with the salaries of the accountants who are responsible for preparing the  Form 1040A . In order to determine their break-even point, they first determine the contribution margin for the  Form 1040A  as shown:

Now they can calculate their break-even point:

Remember, this is the break-even point in units (the number of tax returns) but they can also find a break-even point expressed in dollars by using the contribution margin ratio. First, they find the contribution margin ratio. Then, they use the ratio to calculate the break-even point in dollars:

We can confirm these figures by preparing a contribution margin income statement:

Therefore, as long as Marshall & Hirito prepares 56  Form 1040  income tax returns, they will earn no profit but also incur no loss. What if Marshall & Hirito has a target monthly profit of $10,000? They can use the break-even analysis process to determine how many returns they will need to prepare in order to cover their fixed expenses and reach their target profit:

They will need to prepare 96 returns during the month in order to realize a $10,000 profit. Expressing this in dollars instead of units requires that we use the contribution margin ratio as shown:

Marshall & Hirito now knows that, in order to cover the fixed costs associated with this service, they must generate $38,400 in revenue. Once again, let’s verify this by constructing a contribution margin income statement:

As you can see, the $38,400 in revenue will not only cover the $14,000 in fixed costs, but will supply Marshall & Hirito with the $10,000 in profit (net income) they desire.

As you’ve learned, break-even can be calculated using either contribution margin per unit or the contribution margin ratio. Now that you have seen this process, let’s look at an example of these two concepts presented together to illustrate how either method will provide the same financial results.

Suppose that Channing’s Chairs designs, builds, and sells unique ergonomic desk chairs for home and business. Their bestselling chair is the Spine Saver.  Figure 7.32  illustrates how Channing could determine the break-even point in sales dollars using either the contribution margin per unit or the contribution margin ratio.

Note that in either scenario, the break-even point is the same in dollars and units, regardless of approach. Thus, you can always find the break-even point (or a desired profit) in units and then convert it to sales by multiplying by the selling price per unit. Alternatively, you can find the break-even point in sales dollars and then find the number of units by dividing by the selling price per unit.

College Creations

College Creations, Inc (CC), builds a loft that is easily adaptable to most dorm rooms or apartments and can be assembled into a variety of configurations. Each loft is sold for $500, and the cost to produce one loft is $300, including all parts and labor. CC has fixed costs of $100,000.

• What happens if CC produces nothing?
• Now, assume CC produces and sells one unit (loft). What are their financial results?
• Now, what do you think would happen if they produced and sold 501 units?
• How many units would CC need to sell in order to break even?
• How many units would CC need to sell if they wanted to have a pretax profit of $50,000?

A. If they produce nothing, they will still incur fixed costs of $100,000. They will suffer a net loss of $100,000.

B. If they sell one unit, they will have a net loss of $99,800.

C. If they produce 501 units, they will have operating income of $200 as shown:

D. Break-even can be determined by FC ÷ CM per unit: $100,000 ÷ $200 = 500. Five hundred lofts must be sold to break even.

E. The desired profit can be treated like a fixed cost, and the target profit would be (FC + Desired Profit) ÷ CM or ($100,000 + $50,000) ÷ $200 = 750. Seven hundred fifty lofts need to be sold to reach a desired income of $50,000. Another way to have found this is to know that, after fixed costs are met, the $200 per unit contribution margin will go toward profit. The desired profit of $50,000 ÷ $200 per unit contribution margin = 250. This means that 250 additional units must be sold. To break even requires 500 units to be sold, and to reach the desired profit of $50,000 requires an additional 250 units, for a total of 750 units.

The Effects on Break-Even under Changing Business Conditions

Circumstances often change within a company, within an industry, or even within the economy that impact the decision-making of an organization. Sometimes, these effects are sudden and unexpected, for example, if a hurricane destroyed the factory of a company’s major supplier; other times, they occur more slowly, such as when union negotiations affect your labor costs. In either of these situations, costs to the company will be affected. Using CVP analysis, the company can predict how these changes will affect profits.

Changing a Single Variable

To demonstrate the effects of changing any one of these variables, consider Back Door Café, a small coffee shop that roasts its own beans to make espresso drinks and gourmet coffee. They also sell a variety of baked goods and T-shirts with their logo on them. They track their costs carefully and use CVP analysis to make sure that their sales cover their fixed costs and provide a reasonable level of profit for the owners.

Change in Sales Price

The owner of Back Door has one of her employees conduct a survey of the other coffee shops in the area and finds that they are charging $0.75 more for espresso drinks. As a result, the owner wants to determine what would happen to operating income if she increased her price by just $0.50 and sales remained constant, so she performs the following analysis:

The only variable that has changed is the $0.50 increase in the price of their espresso drinks, but the net operating income will increase by $750. Another way to think of this increase in income is that, if the sales price increases by $0.50 per expresso drink and the estimated sales are 1,500 units, then this will result in an increase in overall contribution margin of $750. Moreover, since all of the fixed costs were met by the lower sales price, all of this $750 goes to profit. Again, this is assuming the higher sales price does not decrease the number of units sold. Since the other coffee shops will still be priced higher than Back Door, the owner believes that there will not be a decrease in sales volume.

When making this adjustment to their sales price, Back Door Café is engaging in  target pricing , a process in which a company uses market analysis and production information to determine the maximum price customers are willing to pay for a good or service in addition to the markup percentage. If the good can be produced at a cost that allows both the desired profit percentage as well as deliver the good at a price acceptable to the customer, then the company should proceed with the product; otherwise, the company will not achieve its desired profit goals.

Change in Variable Cost

In March, the owner of Back Door receives a letter from her cups supplier informing her that there is a $0.05 price increase due to higher material prices. Assume that the example uses the original $3.75 per unit sales price. The owner wants to know what would happen to net operating income if she absorbs the cost increase, so she performs the following analysis:

She is surprised to see that just a $0.05 increase in variable costs (cups) will reduce her net income by $75. The owner may decide that she is fine with the lower income, but if she wants to maintain her income, she will need to find a new cup supplier, reduce other costs, or pass the price increase on to her customers. Because the increase in the cost of the cups was a variable cost, the impact on net income can be seen by taking the increase in cost per unit, $0.05, and multiplying that by the units expected to be sold, 1,500, to see the impact on the contribution margin, which in this case would be a decrease of $75. This also means a decrease in net income of $75.

Change in Fixed Cost

Back Door Café’s lease is coming up for renewal. The owner calls the landlord to indicate that she wants to renew her lease for another 5 years. The landlord is happy to hear she will continue renting from him but informs her that the rent will increase $225 per month. She is not certain that she can afford an additional $225 per month and tells him she needs to look at her numbers and will call him back. She pulls out her CVP spreadsheet and adjusts her monthly fixed costs upwards by $225. Assume that the example uses the original $3.75 per unit sales price. The results of her analysis of the impact of the rent increase on her annual net income are:

Because the rent increase is a change in a fixed cost, the contribution margin per unit remains the same. However, the break-even point in both units and dollars increase because more units of contribution are needed to cover the $225 monthly increase in fixed costs. If the owner of the Back Door agrees to the increase in rent for the new lease, she will likely look for ways to increase the contribution margin per unit to offset this increase in fixed costs.

In each of the prior examples, only one variable was changed—sales volume, variable costs, or fixed costs. There are some generalizations that can be made regarding how a change in any one of these variables affects the break-even point. These generalizations are summarized in Table 7.1.

Changing Multiple Variables

We have analyzed situations in which one variable changes, but often, more than one change will occur at a time. For example, a company may need to lower its selling price to compete, but they may also be able to lower certain variable costs by switching suppliers.

Suppose Back Door Café has the opportunity to purchase a new espresso machine that will reduce the amount of coffee beans required for an espresso drink by putting the beans under higher pressure. The new machine will cost $15,000, but it will decrease the variable cost per cup by $0.05. The owner wants to see what the effect will be on the net operating income and break-even point if she purchases the new machine. She has arranged financing for the new machine and the monthly payment will increase her fixed costs by $400 per month. When she conducts this analysis, she gets the following results:

Looking at the “what-if” analysis, we see that the contribution margin per unit increases because of the $0.05 reduction in variable cost per unit. As a result, she has a higher total contribution margin available to cover fixed expenses. This is good, because the monthly payment on the espresso machine represents an increased fixed cost. Even though the contribution margin ratio increases, it is not enough to totally offset the increase in fixed costs, and her monthly break-even point has risen from $4,125.00 to $4,687.50. If the new break-even point in units is a realistic number (within the relevant range), then she would decide to purchase the new machine because, once it has been paid for, her break-even point will fall and her net income will rise. Performing this analysis is an effective way for managers and business owners to look into the future, so to speak, and see what impact business decisions will have on their financial position.

Let’s look at another option the owner of the Back Door Café has to consider when making the decision about this new machine. What would happen if she purchased the new machine to realize the variable cost savings and also raised her price by just $0.20? She feels confident that such a small price increase will go virtually unnoticed by her customers but may help her offset the increase in fixed costs. She runs the analysis as follows:

The analysis shows the expected result: an increase in the per-unit contribution margin, a decrease in the break-even point, and an increase in the net operating income. She has changed three variables in her costs—sales price, variable cost, and fixed cost. In fact, the small price increase almost gets her back to the net operating income she realized before the purchase of the new expresso machine.

By now, you should begin to understand why CVP analysis is such a powerful tool. The owner of Back Door Café can run an unlimited number of these what-if scenarios until she meets the financial goals for her company. There are very few tools in managerial accounting as powerful and meaningful as a cost-volume-profit analysis.

Long Descriptions

A graph of the Break-Even Point where “Dollars” is the y axis and “Units Sold” is the x axis. A line goes from the origin up and to the right and is labeled “Total Revenue.” Another line, labeled “Total Costs” goes up and to the right, starting at the y axis above the origin and is not as steep as the first line. There is a point where the two lines cross labeled “Break-Even Point.” The space between the lines to the left of that point is colored in and labeled “Loss.” The space between the lines to the right of that point is colored in and labeled “Profit.” Return

A graph of the Break-Even Point where “Dollars” is the y axis and “Birdbaths Sold” is the x axis. A line goes from the origin up and to the right and is labeled “Sales.” Another line, representing “Total Costs” goes up and to the right, starting at the y axis at $18,000 and is not as steep as the first line. There is a point where the two lines cross labeled “Break-Even Point.” There are dotted lines going at right angles from the breakeven point to both axes, showing the units sold are 225 and the cost is $22,500. The space between the lines to the left of that point is colored in and labeled “Loss.” The space between the lines to the right of that point is colored in and labeled “Profit.” Return

A graph of the Break-Even Point where “Dollars” is the y axis and “Birdbaths Sold” is the x axis. A line goes from the origin up and to the right and is labeled “Sales.” Another line, representing “Total Costs” goes up and to the right, starting at the y axis at $18,000 and is not as steep as the first line. There is a point where the two lines cross labeled “Break-Even Point.” There are dotted lines going at right angles from the breakeven point to both axes showing the units sold are 225 and the cost is $22,500. There is also a dotted line at the point at 175 units level going up to the sales and costs lines with a point on each. A dotted line from each is going to the y axis crossing at $21,500 from the cost line and $17,500 from the sales line. The difference between these two points is the $4,000 loss. Return

A graph of the Break-Even Point where “Dollars” is the y axis and “Birdbaths Sold” is the x axis. A line goes from the origin up and to the right and is labeled “Sales.” Another line, representing “Total Costs” goes up and to the right, starting at the y axis at $18,000 and is not as steep as the first line. There is a point where the two lines cross labeled “Break-Even Point.” There are dotted lines going at right angles from the breakeven point to both axes showing the units sold are 225 and the cost is $22,500. There is also a dotted line going up from the units x axis at 300 units to both the cost and the sales lines. The points at which they cross have a dotted line going to the Y axis crossing at $24,000 from the cost point and $28,500 from the sales point. The difference between these two points represents the $6,000 profit. Return

Sales and profit relationships. Sales of 725 units × $100 per unit = $72,500, and variable costs of 725 units × $20 per unit = (14,500) for a contribution margin of $58,000. Fixed costs are (18,000), pre-tax profit is $40,000, and income tax expense of 40% is (16,000) for an after-tax profit of $24,000. Return

Sales Price per Unit $1,250, Cost per Unit $850, Contribution Margin per Unit $400, Fixed Costs $16,800, Fixed Cost divided by Contribution Margin per Unit $16,800 divided by $400, Break-Even in Units 42, Break Even in Dollars 42 times $1,250 equals $52,500, Contribution Margin Ratio (CM divided by Sales or $400 divided by $1,250) 32 percent, Break-even in Sales Dollars (FC divided by CM or $16,800 divided by .32 equals $52,500, Break-Even in Units (Break Even Sales divided by Unit Selling Price or $42,500 divided by $1,250 equals 42 units. Return

Price Change Analysis: With Current Price, With New Price (respectively): Sales Price per Unit $3.75, $4.25; Variable Cost per Unit 1.50, 1.50; Contribution Margin per Unit $2.25, $2.75; Fixed Costs $2,475, $2,475; Break-even in Units 1,100, 900; Break-even in Dollars $4,125, $3,825. Contribution Margin Income Statement: Current Price, New Price (respectively): Unit Sales Expected 1,500, 1,500; Sales $5,625, $6,375; Variable Costs 2,250, 2,250; Contribution Margin $3,375, $4,125; Fixed Costs 2,475, 2,475; Net Income $900, $1,650. Return

Variable Cost Change Analysis: With Current Price, With Increased Variable Cost (respectively): Sales Price per Unit $3.75, $3.75; Variable Cost per Unit 1.50, 1.55; Contribution Margin per Unit $2.25, $2.20; Fixed Costs $2,475, $2,475; Break-even in Units 1,100, 1,125; Break-even in Dollars $4,125, $4,218.75. Monthly Contribution Margin Income Statement: Current Variable Cost, Increased Variable Costs (respectively): Unit Sales Expected 1,500, 1,500; Sales $5,625, $5,625; Variable Costs 2,250, 2,325; Contribution Margin $3,375, $3,300; Fixed Costs 2,475, 2,475; Net Income $900, $825. Return

Fixed Cost Change Analysis: With Current Price, With Increased Fixed Cost (respectively): Sales Price per Unit $3.75, $3.75; Variable Cost per Unit 1.50, 1.50; Contribution Margin per Unit $2.25, $2.25; Fixed Costs $2,475, $2,700; Break-even in Units 1,100, 1,200; Break-even in Dollars $4,125, $4,500. Monthly Contribution Margin Income Statement: Current Fixed Costs, Increased Fixed Costs (respectively): Unit Sales Expected 1,500, 1,500; Sales $5,625, $5,625; Variable Costs 2,250, 2,250; Contribution Margin $3,375, $3,375; Fixed Costs 2,475, 2,700; Net Income $900, $675. Return

Variable Cost and Fixed Cost Change Analysis: With Current Price, With Decreased VC and Increased FC (respectively): Sales Price per Unit $3.75, $3.75; Variable Cost per Unit 1.50, 1.45; Contribution Margin per Unit $2.25, $2.30; Fixed Costs $2,475, $2,875; Break-even in Units 1,100, 1250; Break-even in Dollars $4,125, $4,687.50. Contribution Margin Income Statement: Current Fixed Costs, Increased Fixed Costs (respectively): Unit Sales Expected 1,500, 1,500; Sales $5,625, $5,625; Variable Costs 2,250, 2,175; Contribution Margin $3,375, $3,450; Fixed Costs 2,475, 2,875; Net Income $900, $575. Return

Selling Price, Variable Cost, and Fixed Cost Change Analysis: With Current Price, With Decreased VC and Increased FC, With Increased SP Decreased VC and Increased FC (respectively): Sales Price per Unit $3.75, $3.75, $3.95; Variable Cost per Unit 1.50, 1.45, 1.45; Contribution Margin per Unit $2.25, $2.30, $2.50; Fixed Costs $2,475, $2,875, $2,875; Break-even in Units 1,100, 1,250, 1,150; Break-even in Dollars $4,125, $4,687.50, $4,542.50. Contribution Margin Income Statement: With Current Price, With Decreased VC and Increased FC, With Increased SP Decreased VC and Increased FC (respectively): Unit Sales Expected 1,500, 1,500, 1,500; Sales $5,625, $5,625, 5,925; Variable Costs 2,250, 2,175, 2,175; Contribution Margin $3,375, $3,450, $3,750; Fixed Costs 2,475, 2,875, 2,875; Net Income $900, $575, 875. Return

Financial and Managerial Accounting Copyright © 2021 by Lolita Paff is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.

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Break Even Analysis: Definition, Calculation, and Use (2023)

Do you know your company’s break-even point? If not, you can massively improve your chances of business success by sitting down and crunching some numbers.

A break-even analysis can help you determine how much money you need to become profitable. While this may not apply to all businesses, it’s an important tool to help you understand your financial situation, and it can guide you to make better business decisions.

In this article, we’ll dive into what a break-even point analysis is and how you can calculate it, as well as give some examples and some tricks and tips you can apply along the way.

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What is a break-even analysis?

Simply put, a break-even analysis is a financial calculation that will help you figure out how much money you need to earn before your business idea officially crosses into “profitable” territory. 

To become profitable, you need to be able to cover your daily costs of production and operation, and then earn some extra on top of that.

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Determining your break-even point is also helpful for companies that require a lot of capital and upfront investment to get up and running, like brick-and-mortar stores and businesses with a lot of equipment.

To do a break-even point analysis, you’ll need to understand two key types of cost: fixed and variable.

• Fixed cost: an expense that’s always the same number every month, no matter how many sales you make (e.g., real estate rent, insurance, business taxes)
• Variable cost: an expense that increases or decreases based on how many sales you make (e.g., production costs like raw materials, payroll for hourly employee labor, credit card processing fees)

Advantages of a break-even analysis

There are plenty of advantages to performing a break-even point analysis. Here are a few:

Smarter pricing. You may discover that your prices simply aren’t enough to cover your costs, despite the other factors that went into choosing those prices. At the end of the day, profitability is always the number one driver.

Full financial understanding. It’s easy to overlook expenses when you have a lot of things to consider. But a break-even analysis is a detailed look at your business, and often uncovers things you’ve been missing.

Precise sales goals. Many businesses learn exactly how many sales they need to make per day, week, month, etc., as opposed to the general goal of as many sales as possible (which can be unhelpful when you’re experiencing financial strain!).

Better business decisions. Sometimes, a new business idea seems like a great path. But once you do the math, you may learn that it’s not wise financially. A break-even analysis can help you choose more financially sound options. 

How to calculate break-even point

A break-even point analysis has a clear formula: your fixed costs divided by your average unit price minus your variable costs.

This may seem confusing, so let’s work through it. 

Essentially, you need to figure out how much profit you make on each unit you sell. For example, a unit can be a candle if you’re a candle maker, a lawn mowing service if you have a landscaping company, or a website package if you have a web development company. 

Once you know your profit per unit, divide that number by your fixed costs (the basic costs to run your business that stay the same every month). 

The leftover profit is your contribution margin ratio. It’s called the contribution margin ratio because this amount contributes sales dollars to your fixed costs. 

Note: You can download a free break-even analysis template from Shopify. The US Small Business Administration (SBA) also offers a free break-even calculator .

Collect your business’s data

Gather every single expense you have as a business, including: 

• Fixed costs: Property rent, insurance, software subscriptions, set labor like your accountant’s monthly retainer fee or your salary-based employee pay, etc.
• Variable costs: Raw materials, payment processing fees, non-fixed labor like hourly employee earnings and commission, delivery costs, product packaging costs, etc.
• Average sales price: Calculate a rough average sales price across all your products and services. If you haven’t set firm prices yet, just make an educated guess and you can tweak it later if the numbers don’t work. 

Don’t let a single expense slip through the cracks. This might include variable costs like a set of branded cocktail napkins for a special catering event, or a promotional gift you’re including with your ecommerce orders. 

Plug in the numbers 

Now it’s time to put those numbers into the spreadsheet. We weren’t exaggerating when we said it’s handy: once you add your figures, it’ll calculate your total fixed costs and variable costs. Once you add your average selling price, the spreadsheet will automatically calculate the final break-even point. 

Your final result will show in cell E3, “Break-Even Units.” That’s how many units you need to sell to hit your break-even point. 

The beauty of this spreadsheet is that you can make as many changes and experiments as you want until you reach a configuration that feels feasible and sound for your business.

Break-even-analysis examples: 4 use cases

There are many scenarios for when it makes sense to do a break-even analysis. Examples include: 

1. Starting a new business

Before implementing a business idea, you’ll want to conduct a break-even analysis. Not only will it help you determine whether your idea is viable, it will push you to be realistic about costs and think through your revenue-generating strategy.

2. Changing your business model

If you’re considering changing your business model—for example, switching from carrying products to printing them on demand —you should perform a break-even analysis. This will help you determine whether your prices need to change in response to the significant changes in your startup costs after adopting the new model. 

3. Developing a new product 

Before committing to a new product, you should do a break-even analysis. This is necessary to determine the variable costs related to the new item and set prices. Even if your fixed costs, like utility bills, stay the same, you should still calculate the break-even point to get an idea of the number of units you’ll need to sell to reach profitability. 

4. Adding a new sales channel

Adding a new sales channel can impact your costs, even if your prices remain unchanged. For instance, if you’ve been selling online and now plan to have a pop-up shop , it’s crucial to ensure that you break even to avoid financial strain that may harm your business. 

The same applies to new online sales channels like shoppable posts on TikTok . If you’re planning any additional costs to promote the channel (such as TikTok ads ), your break-even analysis should account for those expenses.

Tips to lower your break-even point

Does your break-even point seem unattainable or far-fetched? This can make you decide against starting a new business. But instead of forgoing the idea of entrepreneurship, you can make some adjustments to lower your break-even point. 

1. Lower variable costs

Reducing your variable expenses can be challenging, especially for new businesses. However, as you grow, it becomes easier to lower these costs. You can attempt to do so by talking to your suppliers, switching to different suppliers, or improving your production method. For instance, you may find that using packing peanuts instead of bubble wrap can lower your shipping costs for delicate items.

2. Raise your prices 

By increasing your prices, you will require fewer sales to reach breakeven. Each unit sold will bring in a higher profit margin. When considering a price hike, consider what the market will accept and what customers will expect. While you’ll need fewer sales, you still must sell enough. If you charge more, customers may expect improved quality or better customer service.

3. Lower fixed costs

Examine the possibility of reducing your fixed costs. The lower they are, the fewer units you need to sell to break even. For instance, if opening a retail store isn’t financially feasible, consider selling through an online platform . Changes like these can significantly lower your fixed costs and, consequently, your break-even point.

Break even to break through

A break-even point analysis doesn’t take a lot of work—it’s a fairly simple financial calculation that can have huge impacts on your business in the long run.

This tool helps business owners and leaders to have a more solid grasp on a company’s finances. Not only does this help with the immediate goal of becoming profitable as soon as possible, but it also helps to steer business decisions for the entire lifetime of the company.

If you’ve never performed a break-even analysis, it’s never too late. Take an hour or two (or perhaps more, depending on the complexity of your business) to crunch the numbers and see where you are and where you can go.

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Break-Even Analysis: Definition and How to Calculate and Use It

Table of Contents

Introduction

When it comes to running a business, understanding your break-even point is crucial. It is the point at which your revenue equals your expenses, and you start making a profit. Break-even analysis is a powerful tool that helps business owners make informed decisions about pricing, costs, and profitability. In this article, we will define break-even analysis, explain how to calculate it, and explore its practical applications.

What is Break-Even Analysis?

Break-even analysis is a financial tool that allows businesses to determine the point at which their total revenue equals their total costs. It helps answer the fundamental question: “How much do I need to sell to cover all my expenses?” By understanding the break-even point, businesses can set realistic sales targets, make pricing decisions, and assess the financial viability of their operations.

Calculating the Break-Even Point

To calculate the break-even point, you need to consider two main components: fixed costs and variable costs.

Fixed Costs

Fixed costs are expenses that do not change regardless of the level of production or sales. These costs include rent, salaries, insurance, and utilities. To calculate the break-even point, you need to determine the total fixed costs for a specific period, such as a month or a year.

Variable Costs

Variable costs, on the other hand, are expenses that vary with the level of production or sales. Examples of variable costs include raw materials, direct labor, and sales commissions. To calculate the break-even point, you need to determine the variable cost per unit and the total number of units sold.

Break-Even Point Formula

The break-even point can be calculated using the following formula:

Break-Even Point (in units) = Fixed Costs / (Selling Price per Unit – Variable Cost per Unit)

For example, let's say a company has fixed costs of $10,000 per month, a selling price per unit of $20, and a variable cost per unit of $10. Using the formula, the break-even point would be:

Break-Even Point (in units) = $10,000 / ($20 – $10) = 1,000 units

This means that the company needs to sell 1,000 units to cover all its costs and reach the break-even point.

Using Break-Even Analysis

Break-even analysis provides valuable insights into a business's financial health and helps guide decision-making. Here are some practical applications of break-even analysis:

Pricing Decisions

Break-even analysis can help businesses determine the optimal pricing strategy. By understanding the break-even point, businesses can calculate the minimum price they need to charge to cover costs and make a profit. It also allows them to assess the impact of price changes on profitability. For example, if a business lowers its price, it can calculate how many additional units it needs to sell to maintain the same profit margin.

Cost Control

Break-even analysis helps businesses identify areas where they can reduce costs to reach the break-even point faster. By analyzing their fixed and variable costs, businesses can identify opportunities for cost savings. For example, they may find that renegotiating a lease agreement or finding a more cost-effective supplier can significantly impact their break-even point.

Investment Decisions

Break-even analysis is also useful when making investment decisions. It helps businesses assess the financial viability of a new project or expansion. By calculating the break-even point for the new venture, businesses can determine whether the potential revenue will cover the additional costs. This analysis provides a clear picture of the risks and rewards associated with the investment.

Scenario Planning

Break-even analysis allows businesses to conduct scenario planning and assess the impact of different variables on their profitability. By adjusting the selling price, variable costs, or fixed costs, businesses can simulate different scenarios and evaluate their financial implications. This helps them make informed decisions and develop contingency plans.

Case Study: Break-Even Analysis in Action

Let's consider a case study to illustrate the practical application of break-even analysis. ABC Electronics is a company that manufactures and sells smartphones. They have fixed costs of $100,000 per month, a selling price per unit of $500, and a variable cost per unit of $300.

Using the break-even formula, we can calculate the break-even point:

Break-Even Point (in units) = $100,000 / ($500 – $300) = 500 units

This means that ABC Electronics needs to sell 500 units to cover all its costs and reach the break-even point.

Now, let's assume ABC Electronics sells 800 units in a month. By subtracting the break-even point from the actual units sold, we can calculate the company's profit:

Profit = (Actual Units Sold – Break-Even Point) * (Selling Price per Unit – Variable Cost per Unit)

Profit = (800 – 500) * ($500 – $300) = 300 * $200 = $60,000

In this case, ABC Electronics would make a profit of $60,000.

Break-even analysis is a powerful tool that helps businesses determine the point at which their revenue equals their expenses. By calculating the break-even point, businesses can make informed decisions about pricing, costs, and profitability. It allows them to set realistic sales targets, make pricing decisions, control costs, and assess the financial viability of their operations. Break-even analysis is a valuable tool for businesses of all sizes and industries, providing insights that can drive success and growth.

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Break Even Analysis (BEA)

Break Even Analysis: this article explains the concept of a Break Even Analysis . After assimilating it, you will be able to understand and calculate this important financial indicator .

What is a Break Even Analysis?

The Break Even Analysis (BEA) is a useful tool to study the relation between fixed costs and variable costs and revenue. It’s inextricably linked to the Break Even Point (BEP), which indicates at what moment an investment will start generating a positive return.

It can be graphically represented or calculated with a simple mathematical calculation. A Break-Even Analysis calculates the size of the production at a certain (selling) price that is necessary to cover all the costs that have been incurred.

Break Even Analysis components

To understand how this analysis works, it’s wise to at least mention the following cost concepts.

Fixed costs

Fixed costs are also called overhead . These costs are always occur after the decision to start an economic activity and they relate directly to the level of production, but not the quantity of production. Fixed costs include (but are not limited to) depreciation of materials, interest costs, taxes and general overhead costs (labour costs, energy costs, depreciation costs).

A carpentry business that mainly makes tables, chairs and closets, employs 50 people. The business has a large number of fixed costs.

It’s about costs that come back every month and stay the same, and can only change after a year. Think for instance of salaries, monthly energy bills and the depreciation costs of current assets (including machines) and fixed assets (such as a building).

Variable costs

Variable costs are costs that change in direct relation to the volume of production. This concerns for instance selling costs, production costs, fuel and other costs that are directly related to the production of goods or an investment in capital.

For a carpentry business, mainly the costs for raw materials, auxiliary materials, semi-finished goods such as wood, nails and copper handles, are variable. If they are producing 50 closets per month, they use less than when they produce 75 closets in some other month. Therefore, these costs vary every month.

Financial Tool

The Break Even Analysis is a handy tool to decide if a company should or should not start producing and selling a product.

In addition, you can calculate the Break Even Point (BEP), also known as the critical point . It is the turnover at which the total revenue would equal the total costs. In that case, the organisation would break even and both the fixed and variable costs will be earned back.

If the turnover is lower than the total costs, it’s a loss. Everything over this critical point can be booked as profit.

Break Even Analysis formula

In order to calculate the Break Even Point within the Break Even Analysis, you need certain data, namely the fixed costs, the selling price of the product and the variable costs per product.

The Break Even Point is determined by the moment when the fixed costs have been earned back. That only happens because of the so-called contribution margin; the selling price minus the variable costs.

When the fixed costs are divided by the contribution margin, you get the Break-Even Point. See the picture below for the Break-Even Point formula:

Break Even Point = fixed costs / ( selling price – variable costs )

Break Even Analysis example

The previously mentioned carpentry business is planning to make a new closet.

It’s a Bohemian model of rough, white-washed woos with two doors and a drawer at the bottom. The closet is almost two metres high, 1.50 metres wide and 0.5 metres deep. There are shelves in the closet and there is an area to hang up clothes, making it suitable as a wardrobe. It would be a good idea for the director to first consider certain data before he decides to start production of the closet.

• The expected selling price is $1,000.
• The fixed costs average $210,000 per year (monthly labour costs, energy costs, interest and depreciation costs).
• The purchasing price of the wood, auxiliary materials and semi-finished products is $400 per closet and make up the variable costs.

With this data, the director will determine the Break-Even Point and he makes the following calculation:

Break Even Point = $210.000 / ( $1000 – $400 ) = 350 items

Cooperation

The above shows that good communication and pleasant cooperation between the Purchasing, Sales and Production departments of a business is very important. Together they will reach a joint conclusion.

It might be impossible for the Sales department to sell more than 350 of these closets.

It might be feasible, but the $1,000 selling price might be too high, leading to the salespeople recommending a more competitive selling price of $750. When that happens, something changes in the Break-Even Point and they will need to sell more than 350 closets before making a profit.

The Purchasing department on the other hand can make sure that raw materials, auxiliary materials and semi-finished products are purchased at more affordable rates, reducing the variable costs. Together with the Sales department, they can also opt to stick to the high selling price, ensuring that they will turn a profit sooner when they sell 350 closets. Lastly, it’s the Production department’s turn.

For them it’s about efficiently handling raw materials. Waste needs to be avoided in order to reduce the variable costs.

An efficient and effective approach will also help with the speed of production, allowing more closets to be produced in less time. Of course, other departments are also linked to this system.

For instance, it’s the Marketing department’s task to offer the closets in an attractive way using various channels, including shops, online shops, design magazines and so on.

Break Even Analysis advantages

The main advantage of a Break-Even Point is that it explains the relationship between costs, production volume and revenue. This analysis can be expanded to show how the changes between fixed and changing cost relations will affect profit levels and the Break-Even Point in for instance product prices or turnovers.

The Break Even Analysis is particularly useful when it is combined with partial budgeting techniques.

It’s Your Turn

What do you think? How do you apply the Break Even Analysis in your business life? Do you recognize the practical explanation or do you have more additions? What are your success factors for conducting financial calculations such as the Break-Even Point?

Share your experience and knowledge in the comments box below.

More information

• Alhabeeb, M. J. (2012). Break‐Even Analysis. Mathematical Finance, 247-273.
• Cafferky, M. (2010). Break Even Analysis . Business Expert Press.
• Gutierrez, P. H., & Dalsted, N. L. (1990). Break-even method of investment analysis. Colorado State University Cooperative Extension.
• Sadiku, M. (2017). Practical Guide on Writing a Persuasive Business Plan: Sample Business Plan, Break-even Analysis, and Detailed Business Plan Outline . Independently published.

How to cite this article: Mulder, P. (2017). Break Even Analysis (BEA) . Retrieved [insert date] from Toolshero: https://www.toolshero.com/financial-management/break-even-analysis/

Published on: 02/27/2017 | Last update: 01/26/2022

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Patty Mulder

Patty Mulder is an Dutch expert on Management Skills, Personal Effectiveness and Business Communication. She is also a Content writer, Business Coach and Company Trainer and lives in the Netherlands (Europe). Note: all her articles are written in Dutch and we translated her articles to English!

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An important business objective is to break even i.e. to exactly cover your total costs by sales revenue. It is even more desirable to make a profit. The diagram below illustrates a firm’s costs and revenues and illustrates three possible situations:

1. Loss-making (outputs to the left of the break-even point)

2. Break-even

3. Profit-making (outputs to the right of the break-even point.)

In order to understand break-even, we first need to define key terms:

Fixed costs:  Costs that do not vary with output or sales e.g. managers’ salaries, rent and rates on business premises.

Variable costs:  Costs that vary with the quantity produced or sold e.g. costs of raw materials, sales staff commissions, etc.

Total cost:  Fixed costs and variable costs at each possible level of output.

Sales revenue:

Profit : The difference between total revenue and total cost (where revenues are higher than costs.

Loss:  The difference between total revenue and total cost (where costs are higher than revenues).

There are two simple ways of calculating the break-even point of a business:

1. Draw a chart showing:

• sales revenue at different levels of output
• fixed costs at different levels of output
• total costs at different levels of output
• the break-even point where total cost = total sales revenue.

2. Calculating the contribution of each unit sold or made. The contribution is the difference between the sales revenue and the variable cost of each unit sold or made.

The number of units needed to be sold (or made) to break even is then calculated by:

We can illustrate break-even by using an example.

An importer buys bottles of a particular type of French wine for £2 a bottle, stores them in a warehouse in this country and then advertises them for sale over the Internet at £4 each. The fixed costs of running the business are £10,000 a month. We can calculate the break-even point by using the two methods, described above:

1. Drawing a chart:

Costs and revenues

2. Calculating contribution per bottle:

Fixed costs = £10,000

Variable cost = £2 per bottle

Sales revenue = £4 per bottle

Contribution = £2 (£4-£2 = £2).

Now work out these two examples on your own:

i. Calculate the break-even point for a newspaper vendor. He buys in newspapers at 20p each and sells them for 50p each. His fixed costs are £60 a day including the rate he pays to the local council. How many newspapers must he sell each day to break even?

ii. A large business has fixed costs of £250,000 per week. Its average sales revenue per item is £2, and its variable costs are on average 50p per item. How many items does it need to sell to break even?

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Breakeven Analysis

BREAK EVEN ANALYSIS Break-even is the point at which a product or service stops costing money to produce and sell, and starts generating a profit for your business.

This means sales have reached sufficient volume to cover the variable and fixed costs of producing and distributing your product. [Type the document subtitle] KOMAL BHILARE ROLL NO: 85 2013 DEFINITION Break Even is: •the sales point at which the Company neither makes profit nor suffers loss, or  •sales level where fixed cost are fully absorbed by or  •the level where contribution margin equals the fixed cost.

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Breakeven analysis provides data for • profit planning • policy formulating and •decision making Break-even analysis may be based on: •historical data, •past operations, or •future sales and costs, Depending on management’s need and desire. •The break even analyses technique is used in various business decision making areas, as this help in knowing the minimum desired level to be achieved to avoid loss situation. •The Breakeven analysis is mostly used at the time of investing in new project and introducing new products.

The organizer of this workshop must have seen Break even for this workshop. USE OF BREAK EVENANALYSES ? Hospital or Hotel management would like to know sales point in terms of number of beds/ rooms, to recover fixed cost to reach at a breakeven point. ?The school owner would be interested in knowing minimum number of students to be admitted to reach at breakeven ?New branch of bank would need to know minimum deposits from customer ?On introduction of new products certain huge sales promotional expenses are planned in order to achieve planned sales. The management while deciding about approving expenditures would be interested to see cost / benefit analyses or minimum expected sales (break even) to be achieved to recover these expenses (disregarding the very ambitious sales budgets submitted by the sales and marketing team) FORMULA A) Breakeven point of output = (fixed cost) / (contribution per unit) Where, Contribution=selling cost – variable cost Fixed cost= Contribution -profit B) Breakeven point of Sales = 1. Fixed price x SP per unit Contribution per unit 2.

Fixed Cost x Total Sales Total Contribution BREAK EVEN GRAPH Uses of Breakeven Chart A breakeven chart can be used to show the effect of changes in any of the following profit factors: • Volume of sales • Variable expenses • Fixed expenses • Selling price PROFIT VOLUME RATIO (P/V RATIO) The ratio of contribution to sales is P/V ratio or C/S ratio.

It is the contribution per rupee of sales and since the fixed cost remains constant in short term period, P/V ratio will also measure the rate of change of profit due to change in volume of sales.

The P/V ratio may be expressed as follows: P/V ratio = Sales – Marginal cost of sales = Contribution Sales Sales = Changes in contribution = Change in profit Changes in sales Change in sales A fundamental property of marginal costing system is that P/V ratio remains constant at different levels of activity. A change in fixed cost does not affect P/V ratio. The concept of P/V ratio helps in determining the following: • Breakeven point Profit at any volume of sales • Sales volume required to earn a desired quantum of profit • Profitability of products • Processes or departments the contribution can be increased by increasing the sales price or by reduction of variable costs. MARGINAL COST A marginal cost is another term for a variable cost. The term ‘marginal cost’ is usually applied to the variable cost of a unit of product or service, whereas the term ‘variable cost’ is more commonly applied to resource costs, such as the cost of materials and labour hours.

Marginal costing is a form of management accounting based on the distinction between: a. the marginal costs of making selling goods or services, and b. fixed costs, which should be the same for a given period of time, regardless of the level of activity in the period. Suppose that a firm makes and sells a single product that has a marginal cost of ? 5 per unit and that sells for ? 9 per unit. For every additional unit of the product that is made and sold, the firm will incur an extra cost of ? 5 and receive income of ? 9.

The net gain will be ? 4 per additional unit.

This net gain per unit, the difference between the sales price per unit and the marginal cost per unit, is called contribution. Contribution is a term meaning ‘making a contribution towards covering fixed costs and making a profit’. Before a firm can make a profit in any period, it must first of all cover its fixed costs. Breakeven is where total sales revenue for a period just covers fixed costs, leaving neither profit nor loss. For every unit sold in excess of the breakeven point, profit will increase by the amount of the contribution per unit LIMITATIONS OF BREAK EVEN ANALYSIS: It is best suited to the analysis of one product at a time.

* It may be difficult to classify a cost as all variable or all fixed; and there may be a tendency to continue to use a break even analysis after the cost and income functions have changed. * Break-even analysis is only a supply side (i. e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. * It assumes that fixed costs (FC) are constant.

Although this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise.

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How to Use NPV In Excel for Break-even Analysis

In this article, we will explore the topic of using NPV (Net Present Value) in Excel for break-even analysis. NPV is an important financial metric that helps businesses assess the profitability or feasibility of an investment by comparing the present value of expected cash flows to the initial cost. Incorporating this concept into Excel allows for efficient and accurate calculations, providing valuable insights for decision-making.

Table of Contents

Understanding the Basics of NPV in Excel

Before diving into break-even analysis, it’s crucial to grasp the fundamentals of NPV. Net Present Value takes into account the time value of money, recognizing that a dollar received in the future is worth less than a dollar received today. By discounting these future cash flows to their present value, NPV allows us to evaluate the profitability of an investment, project, or business venture. By using Excel, we can streamline these calculations and easily perform break-even analysis.

Step-by-Step Guide to Performing Break-even Analysis in Excel

To conduct break-even analysis, which determines the point at which total revenues equal total costs, Excel provides a flexible and powerful tool. Here’s a step-by-step guide to performing break-even analysis in Excel:

• First, identify and categorize your costs into fixed and variable categories. Fixed costs remain constant regardless of the level of production or sales, such as rent or salaries. Variable costs, on the other hand, fluctuate depending on production or sales volume, like raw material or labor costs.
• Next, determine the selling price per unit and the variable cost per unit.
• Now, you can calculate the contribution margin per unit by subtracting the variable cost per unit from the selling price per unit.
• With the contribution margin in hand, divide the fixed costs by the contribution margin to determine the break-even point in units.
• Additionally, you can calculate the break-even point in terms of sales revenue by multiplying the break-even point in units by the selling price per unit.

Why NPV is Important for Break-even Analysis

NPV provides a valuable perspective when conducting break-even analysis. By incorporating the time value of money into the analysis, NPV allows us to assess the long-term profitability of an investment or project. While break-even analysis provides insights into the point of revenue and cost equilibrium, NPV goes a step further by considering the impact over the entire project lifespan. This comprehensive evaluation helps businesses make informed decisions and prioritize investments that generate positive NPV and drive profitability.

Key Concepts and Terms in NPV and Break-even Analysis

When using NPV in Excel for break-even analysis, it’s important to familiarize yourself with key concepts and terms. Understanding these terms will enhance your comprehension of the calculations and enable you to make more accurate evaluations. Some essential terms include:

• Discount Rate: The rate used to discount future cash flows to their present value, reflecting the time value of money.
• Present Value: The current value of an expected future cash flow, obtained by discounting it with a discount rate.
• Initial Cost: The upfront investment or cost required to initiate a project or acquire an asset.
• Cash Flow: The inflows and outflows of money generated by a project or investment over time.
• Break-even Point: The level of production or sales at which total revenues equal total costs, resulting in zero profits or losses.

Setting Up Your Excel Spreadsheet for NPV Calculation

To effectively use NPV in Excel, it’s essential to set up your spreadsheet properly. By organizing the relevant data and creating formulas, you can automate and streamline the calculation process. Here are some important steps to set up your Excel spreadsheet for NPV calculation:

• Create separate columns for the time periods, cash inflows, and discount rate.
• Input the cash inflows for each corresponding time period.
• Define the discount rate, keeping in mind the appropriate rate based on the risk and opportunity cost of capital.
• Use the NPV formula in Excel, referencing the discount rate and cash inflows, to calculate the net present value.

Calculating Net Present Value (NPV) for Break-even Analysis

Now, let’s walk through the steps to calculate NPV in Excel for break-even analysis:

1. Identify the cash inflows and outflows associated with the investment or project.

2. Determine the appropriate discount rate to reflect the time value of money and the project’s risk.

3. In your Excel spreadsheet, enter the cash inflows as positive values and the outflows as negative values, corresponding to the appropriate time periods.

4. Utilize the NPV formula in Excel, referencing the discount rate and the range of cash flows, to calculate the net present value.

5. A positive NPV indicates a profitable investment, while a negative NPV suggests an unprofitable venture.

Interpreting the Results of NPV in Excel for Break-even Analysis

Interpreting the results of NPV in Excel for break-even analysis is crucial for decision-making. Consider the following guidelines:

• A positive NPV value indicates that the investment or project is expected to generate a profit, potentially exceeding the initial cost.
• A negative NPV value suggests that the investment or project may result in a loss, with the present value of expected cash flows falling short of the initial cost.
• Comparing multiple investment options, choose the one with the highest NPV, as it represents the most financially beneficial option.
• Keep in mind that NPV alone doesn’t consider non-financial factors such as market conditions, competition, and risk. Therefore, it’s essential to complement NPV analysis with a comprehensive evaluation.

Exploring Different Scenarios with NPV in Break-even Analysis

An advantage of using NPV in Excel for break-even analysis is the ability to explore various scenarios. By adjusting different variables or assumptions, you can assess the impact on the final NPV. This sensitivity analysis helps in understanding the potential outcomes under different conditions, allowing for more informed decision-making. Excel’s flexibility and versatility enable easy scenario analysis, empowering businesses to make strategic choices based on a range of financial projections.

Tips and Tricks for Using NPV In Excel Effectively for Break-even Analysis

Here are some useful tips and tricks to employ when using NPV in Excel for break-even analysis:

• Regularly review and update your discount rate to reflect changes in the market or business environment.
• Validate the accuracy of your formula inputs and double-check if all the necessary data is included.
• Utilize Excel’s data validation feature to restrict inputs to certain ranges or criteria for consistency and accuracy.
• Consider using Excel’s data tables or goal seek feature to perform sensitivity analysis and assess different scenarios efficiently.
• Save your Excel file regularly and create backups to avoid potential data loss.

Common Mistakes to Avoid When Using NPV In Excel for Break-even Analysis

While using NPV in Excel can be immensely beneficial, it is necessary to be mindful of common mistakes to ensure accurate results. Some mistakes to avoid include:

• Incorrect discount rate: Be cautious when selecting the discount rate, ensuring it appropriately reflects the project’s risk and opportunity cost of capital.
• Missing cash flows: Double-check that all cash inflows and outflows are included, considering the relevant time periods.
• Incorrect signs of cash flows: Ensure that inflows and outflows are correctly represented as positive and negative values in Excel.
• Ignoring qualitative factors: Don’t solely rely on NPV; remember to consider qualitative aspects, such as market trends and competitive landscape.
• Insufficient data validation: Validate all data inputs and formulas to prevent calculation errors and ensure accurate results.

Advanced Techniques in Using NPV In Excel for Break-even Analysis

For more advanced users, Excel offers additional techniques to enhance the usage of NPV in break-even analysis. Some advanced techniques to consider include:

• Using Excel’s solver add-in to identify the optimal values for break-even variables, such as selling price or fixed costs.
• Developing dynamic charts or graphs linked to your break-even analysis to visualize the results and trends.
• Applying Monte Carlo simulation to incorporate uncertainty in cash flow projections and obtain probabilistic NPV estimates.
• Exploring different time periods and discount rates to assess the impact on NPV, allowing for a more comprehensive evaluation.

Real-world Examples and Case Studies of NPV and Break-even Analysis in Excel

To better understand the practical application of NPV and break-even analysis in Excel, let’s examine a couple of real-world examples:

Example 1: New Product Investment

A company is considering launching a new product line. By utilizing NPV in Excel, they conduct break-even analysis to determine the minimum level of sales required to cover all costs and achieve profitability. By inputting the fixed and variable costs, selling price per unit, and projected sales volume, they calculate the break-even point in both units and revenue. The NPV calculation then allows them to assess the long-term profitability of the investment, taking into account the projected cash flows over the product’s lifecycle.

Example 2: Capital Investment Decision

A manufacturing company is contemplating investing in new machinery to increase production efficiency. They utilize NPV in Excel to assess the financial viability of the investment. By inputting the initial cost, expected cash inflows over a defined timeframe, and appropriate discount rate, they calculate the net present value. If the NPV is positive, it indicates that the investment will likely generate a return that exceeds the initial cost. This analysis helps the company prioritize investments and allocate resources effectively.

Best Practices for Presenting NPV Results from Break-even Analysis in Excel

When presenting NPV results from break-even analysis in Excel, it is important to maintain clarity and professionalism. Here are some best practices to follow:

• Include a clear title indicating the analysis being performed, such as “Break-even Analysis with NPV Results.”
• Present the key input values, such as fixed costs, variable costs per unit, selling price, and projected sales volume.
• Show the calculated break-even point in units and revenue, providing an understanding of the minimum level of sales required for profitability.
• Display the calculated NPV value, indicating the projected profitability or return on investment.
• Utilize tables and charts to present the data visually, facilitating easier comprehension and interpretation.
• Add explanatory notes or captions to clarify the meaning and implications of the results.

Comparing Different Methods of Calculating Break-even Point with NPV in Excel

While NPV is often used to assess the long-term profitability of investments, it is essential to consider other methods for calculating the break-even point. Some alternative methods include:

• Contribution Margin Ratio: Instead of calculating the break-even point in units, this method determines the break-even point as a percentage of the sales revenue.
• Target Profit Analysis: This approach focuses on identifying the necessary sales volume to achieve a specific target profit, in addition to covering all costs.
• Weighted Average Contribution Margin: By considering different products with varying contribution margins, this method calculates the overall break-even point by weighting the contribution margins based on their sales mix.
• Margin of Safety Analysis: This method determines the cushion or buffer zone between the break-even point and the actual sales volume, indicating the level of risk or flexibility in the business operations.

By considering and comparing different methods, businesses can gain a holistic understanding of their break-even point and make more informed decisions based on their specific circumstances and objectives.

In conclusion, mastering the use of NPV in Excel for break-even analysis can significantly enhance financial decision-making for businesses. By understanding the basics, setting up Excel spreadsheets effectively, and avoiding common mistakes, you can accurately calculate and interpret NPV results. Additionally, exploring advanced techniques and real-world examples further enhances your knowledge and ability to conduct break-even analysis with NPV in Excel. Applying best practices when presenting results and considering alternative methods of break-even analysis ensures a comprehensive analysis of profitability and financial feasibility.

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Break-Even Analysis – Definition, Formula & Examples

Updated on : Mar 18th, 2021

A break-even analysis is a financial tool which helps a company to determine the stage at which the company, or a new service or a product, will be profitable. In other words, it is a financial calculation for determining the number of products or services a company should sell or provide to cover its costs (particularly fixed costs). 

What is a Break-Even Analysis

Break-even is a situation where an organisation is neither making money nor losing money, but all the costs have been covered.

Break-even analysis is useful in studying the relation between the variable cost, fixed cost and revenue. Generally, a company with low fixed costs will have a low break-even point of sale. For example, say Happy Ltd has fixed costs of Rs. 10,000 vs Sad Ltd has fixed costs of Rs. 1,00,000 selling similar products, Happy Ltd will be able to break-even with the sale of lesser products as compared to Sad Ltd.

Components of Break-Even Analysis

Fixed costs Fixed costs are also called overhead costs. These overhead costs occur after the decision to start an economic activity is taken and these costs are directly related to the level of production, but not the quantity of production. Fixed costs include (but are not limited to) interest, taxes, salaries, rent, depreciation costs, labour costs, energy costs etc. These costs are fixed irrespective of the production. In case of no production also the costs must be incurred.

Variable costs Variable costs are costs that will increase or decrease in direct relation to the production volume. These costs include cost of raw material, packaging cost, fuel and other costs that are directly related to the production.

Calculation of Break-Even Analysis

The basic formula for break-even analysis is derived by dividing the total fixed costs of production by the contribution per unit (price per unit less the variable costs).

For an example: Variable costs per unit: Rs. 400 Sale price per unit: Rs. 600 Desired profits: Rs. 4,00,000 Total fixed costs: Rs. 10,00,000 First we need to calculate the break-even point per unit, so we will divide the Rs.10,00,000 of fixed costs by the Rs. 200 which is the contribution per unit (Rs. 600 – Rs. 200). Break-Even Point = Rs. 10,00,000/ Rs. 200 = 5000 units Next, this number of units can be shown in rupees by multiplying the 5,000 units with the selling price of Rs. 600 per unit. We get Break-Even Sales at 5000 units x Rs. 600 = Rs. 30,00,000. (Break-even point in rupees)

Contribution Margin

Break-even analysis also deals with the contribution margin of a product. The excess between the selling price and total variable costs is known as contribution margin. For an example, if the price of a product is Rs.100, total variable costs are Rs. 60 per product and fixed cost is Rs. 25 per product, the contribution margin of the product is Rs. 40 (Rs. 100 – Rs. 60). This Rs. 40 represents the revenue collected to cover the fixed costs. In the calculation of the contribution margin, fixed costs are not considered.

When is Break-even analysis used

• Starting a new business:  To start a new business, a break-even analysis is a must. Not only it helps in deciding whether the idea of starting a new business is viable, but it will force the startup to be realistic about the costs, as well as provide a basis for the pricing strategy.
• Creating a new product:  In the case of an existing business, the company should still peform a break-even analysis before launching a new product—particularly if such a product is going to add a significant expenditure.
• Changing the business model:  If the company is about to the change the business model, like, switching from wholesale business to retail business, then a break-even analysis must be performed. The costs could change considerably and breakeven analysis will help in setting the selling price.

Breakeven analysis is useful for the following reasons:

• It helps to determine remaining/unused capacity of the company once the breakeven is reached. This will help to show the maximum profit on a particular product/service that can be generated.
• It helps to determine the impact on profit on changing to automation from manual (a fixed cost replaces a variable cost).
• It helps to determine the change in profits if the price of a product is altered.
• It helps to determine the amount of losses that could be sustained if there is a sales downturn.

Additionally, break-even analysis is very useful for knowing the overall ability of a business to generate a profit. In the case of a company whose breakeven point is near to the maximum sales level, this signifies that it is nearly impractical for the business to earn a profit even under the best of circumstances. Therefore, it’s the management responsibility to monitor the breakeven point constantly. This monitoring certainly reduces the breakeven point whenever possible.

Ways to monitor Break-even point

• Pricing analysis:  Minimize or eliminate the use of coupons or other price reductions offers, since such promotional strategies increase the breakeven point.
• Technology analysis:  Implementing any technology that can enhance the business efficiency, thus increasing capacity with no extra cost.
• Cost analysis:  Reviewing all fixed costs constantly to verify if any can be eliminated can surely help. Also, review the total variable costs to see if they can be eliminated. This analysis will increase the margin and reduce the breakeven point.
• Margin analysis:  Push sales of the highest-margin (high contribution earning) items and pay close attention to product margins, thus reducing the breakeven point.
• Outsourcing:  If an activity consists of a fixed cost, try to outsource such activity (whenever possible), which reduces the breakeven point.

Benefits of Break-even analysis

• Catch missing expenses:  When you’re thinking about a new business, it’s very much possible that you may forget about a few expenses. Therefore, a break-even analysis can help you to review all financial commitments to figure out your break-even point. This analysis certainly restricts the number of surprises down the road or atleast prepares a company for them.
• Set revenue targets:  Once the break-even analysis is complete, you will get to know how much you need to sell to be profitable. This will help you and your sales team to set more concrete sales goals.
• Make smarter decisions:  Entrepreneurs often take decisions in relation to their business based on emotion. Emotion is important i.e. how you feel, though it’s not enough. In order to be a successful entrepreneur, decisions should be based on facts.
• Fund your business:  This analysis is a key component in any business plan. It’s generally a requirement if you want outsiders to fund your business. In order to fund your business, you have to prove that your plan is viable. Furthermore, if the analysis looks good, you will be comfortable enough to take the burden of various ways of financing.
• Better pricing: Finding the break-even point will help in pricing the products better. This tool is highly used for providing the best price of a product that can fetch maximum profit without increasing the existing price.
• Cover fixed costs:  Doing a break-even analysis helps in covering all fixed cost.

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• Break-Even Analysis

Introduction to Break-Even Analysis

Break-even analysis is an essential economic tool that helps to determine the point beyond which a company earns a profit. It helps businesses calculate the volume of products that need to be sold so that a company overcomes all the initial cost of investment. Reaching this break-even point means that a company is no more in a state of loss.

What is the Break-Even Point? 

In a business scenario, the break-even point is a perimeter at which the total expenses of the enterprise equals the total revenue generated. Reaching this point indicates that a business has overcome all the expenses and no more in a state of loss. 

Since this calculation reveals such vital information of a business, it is a necessity to learn and calculate break-even points accurately. 

To understand this further, consider this formula. 

Break-even point = Fixed Cost / (Price per cost - Variable cost) = Fixed Cost / Gross Profit Margin

Where, 

Fixed cost refers to the cost incurred in a business unit, which doesn’t depend upon the volume of production. For example, rent, loans, insurance premiums, etc. comes under fixed cost. 

Variable cost is the cost to produce one unit of product. 

Example 

Let us understand this equation by taking a break even analysis example mentioned as follows. 

A factory ABC Enterprises produces a particular kind of good wherein the total fixed costs stands at Rs.50,000 and variable cost to produce a good is Rs.30. The company sold these goods with a sale price per unit of Rs.50. 

In this case, 

Break-even point = 50,000/ (50-30) = 2500 units 

So, from the above break-even analysis, it is evident that BEP (break-even point) for ABC enterprises stands at 2500. This means a company will have to sell at least 2500 units of the product to overcome these fixed and variable costs incurred for production. 

This can further help companies in determining the total sales achieved by the company then. They need to multiply the break-even point with the sale price per unit to do so. In this case, the value of total sales made by the company at their break-even point will be equal to (2500*50) Rs.1,25,000. 

Numerical to Solve 

A company produces goods at a variable cost of Rs.12 per unit, and the same is sold at Rs.20 per unit. Fixed cost incurred by a company for a period stands at Rs.40,000. Calculate the number of products a company needs to manufacture to attain a profit target of Rs.10,000. 

Check the following table to know about cost analysis for 6 months of a business operation. 

Calculate the breakeven quantity 

Draw break-even chart for the 6 months of business operation 

Determine the profit earned by an organization 

Fixed costs of an enterprise is Rs.3,00,000, and the variable cost and selling price of the product is Rs.42 per unit and Rs.72 per unit, respectively. The company expects to sell 15,000 units of the product whereas it has a maximum factory capacity of 20,000 units. Draw a break-even chart depicting the break-even point and determine the profit earned at this current situation. 

Students can solve these numerical quickly and accurately after they have a thorough understanding of the concept of break-even analysis. To understand why we need to calculate this, look at its importance in detail.

Significance of Break-Even Analysis 

Determined Volume of Products to be Sold 

As per the break even analysis definition, its calculation can help companies determine the minimum number of goods to be sold so that the total fixed and variable cost of production is met. Therefore, a company already has an exact figure about the number of units to be sold to overcome losses. 

Deciding Budgets and Targets 

Since break-even analysis gives businesses an idea about the operational scenario, it helps plan the budget for various business operations. Besides, they can set objectives to accelerate the production speed and achieve them positively. 

Cost Control 

Fixed and variable costs may have an impact on an organization's profit margin. But, with break-even analysis of the business operations, they will be able to evaluate if any effects are changing the value of cost. In such scenarios, controlling cost becomes a necessity to ensure they earn profit from business operations. 

Designing of Price Strategy 

Pricing of products has a huge impact on the calculation of break-even points. For instance, if the price of goods increases, then understandably their break-even point will be reduced. For example, if earlier an organization needed to sell 50 units of this product to reach breakeven, it will be attained at only 45 units if the selling price is increased. 

Margin of Safety Management 

Sales of goods can significantly decline in a situation of financial crisis or breakdown. In such scenarios, managing margin of safety becomes easier with concepts like break even analysis. That’s because the company will have an idea on the minimum number of products they need to sell to ensure their organization doesn’t undergo any loss.

The margin of safety can be calculated by the following formula, 

Margin of safety = (current sales level – Break-even point)/ Current sales level 

Or, Margin of safety = (current sales level – Break-even point)/ Selling price per unit  

These are a few pointers which briefly discuss why it is important to calculate break-even points and study them in a business environment. 

Components of Break-even Analysis 

The two components that help define break-even analysis are mentioned as follows 

Fixed Cost 

Costs incurred in running a business that doesn’t vary with the volume of the production are known as a fixed cost. Also known as an overhead cost, examples of fixed costs are salaries, rent, premiums, loans, bills, etc. 

Variable Cost 

This is the cost that varies as the number of manufactured products fluctuates. Cost of fuel, raw material, packaging, etc. comes under this.

Applications of Break-Even Analysis 

Planning in New Businesses

New businesses have a lot to plan before they introduce a facility and start manufacturing goods for sale. To ensure the plans regarding cost and pricing of goods are done right, break even analysis is a necessity. One will be able to analyze and state if the new business idea is productive or not. 

Introduction of New Products 

For cases, a company wishes to introduce the production of new products in its business unit; the study of break-evens can emerge very significant. Before they start producing the goods, analyzing break-even will help them understand the cost and pricing strategy. 

Business Model Modification 

Change in a business model may have an impact on your businesses productivity. The change of model doesn’t necessarily mean it will affect the costs and expenses, but if that’s the case, it will help you change your selling price accordingly. Hence, analyzing break-even in this scenario is both feasible and important. 

Further, while discussing, the term marginal costing and break even analysis may appear frequently. Marginal cost is the extra cost incurred in producing one extra unit of a good. This can help determine how variable costs can affect the volume of production in a business unit. 

Understanding break even analysis meaning will help students get an in-depth idea about this economic concept. Students looking for comprehensive study material can browse to Vedantu’s official website or download the app to access the study notes. All our study materials are prepared by experienced and qualified teachers and are guaranteed to help students learn the nuances of the subject intricately. 

Break-even analysis is an essential economic tool that is used to determine the cost structure of a company or the number of units or services that need to be sold in order to cover the expenditure done by it. Break-even is a condition in which the company makes no profit nor suffers any loss, it just recovers all the money spent on the development of a  product.

The break-even analysis is used to examine the relation between the fixed cost, variable cost, and revenue generated by a company. Usually, a company with a low fixed cost will have a low break-even point of sale.

Importance of Break-Even Analysis

Determines the Size of Units to be Sold: Break-even analysis helps a company in determining the number of units that needs to be sold in order to cover the cost. Variable cost and selling price of an individual product along with the total cost, are required to evaluate the break-even analysis.

Budgeting and Setting Targets: It allows a company to set a budget and fix a goal and work accordingly since the owner knows at which point their company can break even. It also helps the company in setting an achievable target.

Organizing the Margin of Safety: In times of a financial breakdown, when the company is not performing well, it helps in deciding the minimum number of sales the company requires to make a profit. With the margin of safety reports, the management of the company can take its business decisions accordingly.

Monitors and Controls Cost: The fixed and variable cost of a product can affect the profit margins of a company. Therefore, the break-even analysis can help the management detect if any effects are changing the cost.

Helps to Design Pricing Strategy: If the selling price of a product is increased then the quantity of product to be sold for break-even will be reduced. And like that, if the selling price is reduced, then a company needs to sell extra to break even. So it also helps in designing the pricing strategy of a product.

Components of Break-Even Analysis

Fixed Costs: These costs are also known as overhead costs. These costs come into existence once the financial activity of a business starts. The fixed costs include taxes, salaries, rents, depreciation cost, labor cost, interests, energy cost, etc.

Variable Costs: These costs are called variable costs because they decrease or increase according to the volume of the production. Variable costs include packaging cost, cost of raw material, fuel, and other materials related to production.

Applications of Break-Even Analysis

New Business: This guides the company regarding the productivity of a new business so for a new venture, a break-even analysis is essential. It helps the management in formulating the pricing strategy and is practical about the cost.

Manufacture New Products: Before launching a new product the company needs to check the break-even analysis before starting its production and see if the product adds necessary expenditure to the company.

Change in Business Model: The break-even analysis helps a company in determining whether they need to change the selling price of a product if there is any change in any business model like shifting from retail business to wholesale business. 

Break-Even Analysis Formula

Break-even point = Fixed cost/-Price per cost – Variable cost

Example of Break-Even Analysis

Suppose a company is selling a pen. The company first determines the fixed costs (lease, property tax, and salaries) which sums up to  ₹1,00,000. The variable cost determined by the company for one pen is  ₹2 per unit. And , the pen is sold at a price of ₹10.

Therefore, to determine the break-even point of Company, the pen will be:

Break-even point = Fixed cost/Price per cost – Variable cost

= ₹1,00,000/(₹12 – ₹2)

= 1,00,000/10

Therefore, with the given variable costs, fixed costs, and selling price of the pen, the company  would need to sell 10,000 units of pens to break-even.

FAQs on Break-Even Analysis

1. What is Break Even Analysis?

Break even analysis is an essential economic tool which helps to determine the point beyond which a company starts earning profit. It helps businesses in accurately calculating the volume of products which needs to be sold so that a company overcomes all the initial cost of investment. In simple words Break-even analysis determines the number of units or amount of revenue that a company must generate in order to cover the total expenditure done by it on the development of a product or service.

2. Explain Break Even Analysis.

It is an economic tool which helps calculate the point beyond which a company isn’t any more in a loss. They reach a point in business operations wherein the total costs equal the total revenue generated.

3. Write Down the Break Even Sales Formula.

The break-even sales can be calculated by multiplying the selling price per unit with the break-even point, i.e., the number of units to be produced. This break-even point can be calculated by the formula (Fixed cost / price per cost – variable cost).

4. Where can I find useful study resources for understanding Break-Even analysis?

You can find everything you need on the Vedantu app or website. These resources are created by professionals in the field and the content is accurate and reliable. Students can find information like Components, Significance, Applications of break-even analysis and a whole lot more! These study materials are completely free and there is no cost involved. All students just have to sign in and then they will be able to download what they want in pdf format. Students can take advantage of these free resources that will surely help you ace your exams. 

5. What is the Break-Even point?

For a company, the break-even point is a condition in which the total expenses of the enterprise equals the total revenue generated. When a company reaches the break-even point it means that it has overcome all the expenses and is no longer in a state of loss. Since this calculation reveals such vital information of a business, it is necessary to learn and calculate the break-even point accurately. Formula for break-even point :

6. What are the Components of Break-Even analysis?

Fixed costs: These costs are also known as overhead costs. These costs come into existence once the financial activity of a business starts. The fixed costs include taxes, salaries, rents, depreciation cost, labor cost, interests, energy cost, etc.

Variable costs: These costs are called variable costs because they decrease or increase according to the volume of the production. Variable costs include packaging cost, cost of raw material, fuel, and other materials related to production.

5. What are the applications of Break-Even Analysis?

New businesses have a lot to plan before they introduce a facility and start manufacturing goods for sale. To ensure that the plan works regarding cost and pricing of goods are done right, break even analysis is a necessity. Anyone will be able to analyze and state if the new business idea is productive or not. 

•   Introduction of New Products 

For cases, a company wishes to introduce the production of new products in its business unit; the study of break-evens can emerge very significant. Before starting to produce, the goods analyzing break-even will help them understand the cost and pricing strategy. 

•   Business Model Modification 

Change in a business model may have an impact on your businesses productivity. The change of model does not always mean that it will affect the costs and expenses, but if that’s the case, it will help you change your selling price accordingly. Hence, inspecting break-even in this scenario is both feasible and important. Further, the term marginal costing and break even analysis may appear frequently. Marginal cost is the type of extra cost incurred in producing one extra unit of a good. This will help in determining how variable costs can affect the volume of production in a business unit.