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What Is Break Even Analysis

Break even analysis is a calculation that determines the quantity of units or amount of revenue needed to equal total expenses. It examines a company's fixed costs in relation to profits earned from each unit sold. The break even point is calculated using a formula that divides fixed costs by the contribution margin per unit. This analysis allows businesses to determine how many units they need to sell to start earning a profit and provides a benchmark for profitability.

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Elaine Magbuhat
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70 views

What Is Break Even Analysis

Break even analysis is a calculation that determines the quantity of units or amount of revenue needed to equal total expenses. It examines a company's fixed costs in relation to profits earned from each unit sold. The break even point is calculated using a formula that divides fixed costs by the contribution margin per unit. This analysis allows businesses to determine how many units they need to sell to start earning a profit and provides a benchmark for profitability.

Uploaded by

Elaine Magbuhat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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What Is Break Even Analysis?

Break even analysis is a calculation of the quantity sold which generates


enough revenues to equal expenses. In securities trading, the meaning of
break even analysis is the point at which gains are equal to losses.

Another definition of break even analysis is the examination and calculation


of the margin of safety that’s based on a company’s revenue – as well as
the related costs of running the organization.
How Is Break Even Analysis Used?

A break-even analysis helps business owners determine when they'll begin


to turn a profit, which can help them better price their products. Usually,
management uses this metric to help guide strategic decisions to
grow/maintain the business.

Break-Even Analysis vs. Break-Even Point

Break-even analysis uses a calculation called the break even point (BEP)
which provides a dynamic overview of the relationships among revenues,
costs, and profits. More specifically, it looks at a company’s fixed costs in
relation to profits that are earned from each unit sold.

Break Even Analysis Varies Among Industries

Typical variable and fixed costs differ widely among industries. This is why
comparison of break-even points is generally most meaningful among
companies within the same industry. The definition of a 'high' or 'low' break-
even point should be made within this context.

Break Even Analysis Formula

The following formula can be used to calculate the number of units that a
business needs to sell in order to break even:
Fixed Costs

Fixed costs do not change with the quantity of output. In other words,
they’re not affected by sales. Examples include rent and insurance
premiums, as well as fees paid for marketing or loan payments.

Variable Costs

Variable costs change depending on the amount of output. Examples


include raw materials and labor that are directly involved in a company's
manufacturing process.

Contribution Margin

The contribution margin is the amount remaining (i.e. the excess) after total
variable costs are deducted from a product’s selling price.

Say that an item sells for $5,000 and your total variable costs are $3,000
per unit. Your contribution margin would be $2,000 (after subtracting
$3,000 from $5,000). This is the revenue that’ll be used to cover your fixed
costs – which isn’t considered when calculating the contribution margin.

Earned Profit

Earned profit is the amount a business earns after taking into account all
expenses. You can calculate this number by subtracting the costs that go
into your company’s operations from your sales.
Example of Break Even Analysis

In this break even analysis sample, Restaurant ABC only sells pepperoni
pizza. Its variable expenses for each pizza include:

 Flour: $0.50

 Yeast: $0.05

 Water: $0.01

 Cheese: $3.00

 Pepperoni: $2.00

Adding all of these costs together, we determine that it has $5.56 in


variable costs per pizza. Based on the total variable expenses per pizza,
Restaurant ABC must price its pizzas at $5.56 or higher to cover those
costs.

The fixed expenses per month include:

 Labor: $1,500

 Rent: $3,000

 Insurance: $200

 Advertising: $500

 Utilities: $450

In total, Restaurant ABC's fixed costs are $5,650.

Let’s say that each pizza is sold for $10.00. Therefore the contribution
margin is $4.44 ($10.00 - $5.56).
To determine the number of pizzas (or units) Restaurant ABC needs to sell,
take its fixed costs and divide them by the contribution margin:

$5,650 ÷ $4.44 = 1,272.5

This means the restaurant needs to sell at least 1,272.53 pizzas (rounded
up to 1,273 whole pizzas), to cover its monthly fixed costs. Or, the
restaurant needs to have at least $12,730 in sales (1,272.5 x $10) to reach
the break-even point.

Note: If your product must be sold as whole units, you should always round
up to find the break-even point.

Remember: Fixed Costs Can Increase

Some fixed costs increase after a certain level of revenue is reached. For
example, if Restaurant ABC begins selling 5,000 pizzas per month – rather
than 2,000 – it might need to hire a second manager, thus increasing labor
costs.

Break-Even Analysis Benefits

Break-even analysis is a great way to determine a business’ profitability. It


can show business owners and management how many units need to be
sold in order to cover both fixed and variable expenses. It also provides a
specific benchmark or goal so businesses not only survive but also remain
profitable.

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