Break Even Analysis

Break Even Analysis
DEFINITION
Breakeven analysis is the business analysis performed to determine the
probable point when your business will be able to cover all its expenses
and begin to make a profit. Breakeven analysis can be done to determine
either the breakeven point or the breakeven volume.
Breakeven Point:
It is the point in your business transactions when profit is exactly equal
to the costs of doing business. It is the point that above it, the business
starts making profit (revenue exceeds costs), all factors remaining
constant. At the breakeven point: TOTAL REVENUE = TOTAL COST
Breakeven point can be determined in terms of:
a. Time - how long will you be in business to be able
to start making profit?
b. Units of sales – how many units of your product
will you will be able to sell before making profit?
c. Sales revenue – how much revenue do you need to
generate to start making profit?
NOTE: (1) All three perspectives are inter-related, therefore, the choice
of which metric- time, units of sales, or sales volume – to adopt is
personal.
(2) Breakeven point can be defined from the standpoint of each of
these perspectives.
THE IMPORTANCE OF BREAKEVEN POINT:
1. It helps to identify your start-up costs
2. It also helps to determine the sales revenue needed to pay for
ongoing business expenses.
3. Breakeven point analysis helps the business to determine its gross
(or contribution) margin
4. Breakeven point analysis aids in developing proper product pricing
strategy through knowledge of its gross and contribution margin.
5. The breakeven point is an important reference point that enters into
planning and carrying out business activities.
6. A clear understanding of the sales volume needed to cover all costs
(mentioned in point 2 above) helps the business to know:
(a) How many units the business must produce and
sell in terms of manufacturing business
(b) How many units to purchase and sell in the case of
the merchandising business
(c) In the services unit, the breakeven point indicates
the number of billable hours you must work in
order to cover your costs.
7. It helps in examining the effects of on-going business processes or
activities on the organization’s profitability.
8. It helps in deciding about the substitution of new plants (and
products).
9. It is an essential component of a business or marketing plan, and is
normally incorporated in the feasibility studies.
Formula
The break-even point formula is calculated by dividing the total fixed
costs of production by the price per unit less the variable costs to produce
the product.
Since the price per unit minus the variable costs of product is the
definition of the contribution margin per unit, you can simply rephrase
the equation by dividing the fixed costs by the contribution margin.
This computes the total number of units that must be sold in order for the
company to generate enough revenues to cover all of its expenses. Now
we can take that concept and translate it into sales dollars.
The break-even formula in sales dollars is calculated by multiplying the
price of each unit by the answer from our first equation.
This will give us the total dollar amount in sales that will we need to
achieve in order to have zero loss and zero profit. Now we can take this
concept a step further and compute the total number of units that need to
be sold in order to achieve a certain level profitability with out break-
even calculator.
First we take the desired dollar amount of profit and divide it by the
contribution margin per unit. The computes the number of units we need
to sell in order to produce the profit without taking in consideration the
fixed costs. Now we must add back in the break-even point number of
units. Here’s what it looks like.
Example
Let’s take a look at an example of each of these formulas. Barbara is
the managerial accountant in charge of a large furniture factory’s
production lines and supply chains. She isn’t sure the current year’s
couch models are going to turn a profit and what to measure the number
of units they will have to produce and sell in order to cover their expenses
and make at $500,000 in profit. Here are the production stats.
 Total fixed costs: $500,000
 Variable costs per unit: $300
 Sale price per unit: $500
 Desired profits: $200,000
First we need to calculate the break-even point per unit, so we will divide
the $500,000 of fixed costs by the $200 contribution margin per unit
($500 – $300).
As you can see, the Barbara’s factory will have to sell at least 2,500 units
in order to cover it’s fixed and variable costs. Anything it sells after the
2,500 mark will go straight to the CM since the fixed costs are already
covered.
Next, Barbara can translate the number of units into total sales dollars by
multiplying the 2,500 units by the total sales price for each unit of $500.
Now Barbara can go back to the board and say that the company must sell
at least 2,500 units or the equivalent of $1,250,000 in sales before any
profits are realized. She can also take it a step further and use a break-
even point calculator to compute the total number of units that must be
produced in order to meet her $200,000 profitability goal by dividing the
$200,000 desired profit by the contribution margin then adding the total
number of break-even point units.
These are just examples of the break-even point. You can use these as a
template for your business or course work.

Break Even Analysis

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