Cost-Volume-Profit (CVP)

Break-Even Analysis

Break-Even Point

If a company is not able to cover fixed costs, then it is not making a profit. Companies calculate a break-even point to find out when they will begin to make a profit.

Companies calculate their break-even point to determine if they will lose money under certain conditions. From an accounting perspective, the break-even point is where revenue equals total costs. At this point, the organization is neither losing nor making money. Determining the break-even point tells a company how much of a product it must sell, and at what price, to break even. The break-even analysis considers total costs (both fixed and variable). Other than simply providing a break-even point, a break-even analysis highlights income and expenses to show a company its areas of improvement to reduce costs and increase profit.

Break-even analysis provides a lot of useful information. For example, if the break-even analysis demonstrates that the sales price of the unit is too low, then the company might consider whether its costs are too high or whether the unit's sales price can be increased. However, increasing the unit's sales price may make the unit more expensive than similar products on the market. In that case, competition may harm the total sales of the units, and the company will likely not come near to breaking even.

Relationship between Cost, Volume, and Profit

A company's costs, profits, and sales volume are all essential components in determining a company's break-even point.

Calculation of Breakeven

The break-even point can be calculated in terms of both units and revenue.
Two equations may be used to calculate a company's break-even point. First, the company can compute its break-even point in terms of units. In other words, the company can calculate how many units it needs to sell so it can break even. In this case, the company divides its total fixed costs by the unit's contribution margin.
Break-Even Point=Total Fixed CostsContribution Margin\text{Break-Even Point}=\frac{\text{Total Fixed Costs}}{\text{Contribution Margin}}
For example, if a company has fixed costs of $10,000 and its contribution margin is $10, then the break-even point is 1,000 units.
Break-Even Point=$10,000$10=1,000units\text{Break-Even Point}=\frac{\$10{,}000}{\$10}=1{,}000\;\text{units}
As such, as long as the company sells 1,000 units, its revenue minus expenses will equal zero. This break-even method may help companies determine how many units to produce and divide among different distributors. A company can also calculate its break-even point in terms of revenue. This method tells the company how much it must earn from the sale of the units to break even. To do this, companies divide the total fixed costs by the contribution margin ratio per unit. The contribution margin ratio provides a percentage of how much of a single dollar of revenue goes toward fixed costs. Companies calculate the contribution margin ratio by dividing the contribution margin per unit by the unit's sales price.
Contribution Margin Ratio=Contribution Margin Per UnitUnit Sales Price\text{Contribution Margin Ratio}=\frac{\text{Contribution Margin Per Unit}}{\text{Unit Sales Price}}
For example, a company has fixed costs of $5,000, has a contribution margin of $10, and plans to sell its units for $40 each. First, the company needs to compute its contribution margin ratio per unit, which is the contribution margin per unit divided by the sales price per unit. Here, the contribution margin ratio per unit is 25% ($10 contribution margin divided by $40 sales price per unit). Next, the company needs to compute its break-even revenue by dividing its total fixed costs of $5,000 by the 25% contribution margin ratio per unit. Thus, the company must have revenue of $20,000 to break even. This break-even method helps companies decide how to price their units.
Contribution Margin Ratio=$10$40=25%\begin{aligned}\text{Contribution Margin Ratio}&=\frac{\$10}{\$40}=25\%\end{aligned}
Break-Even Point=Total Fixed CostsContribution Margin Ratio=$500025%=$20,000\begin{aligned}\text{Break-Even Point}&=\frac{\text{Total Fixed Costs}}{\text{Contribution Margin Ratio}}\\\\&=\frac{\$5000}{25\%}=\$20{,}000\end{aligned}