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 (BEA)?

The Break Even Analysis (BEA) is a useful tool to study the relation between fixed costs and variable costs and revenue. It’s
indivisibly 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.

Purpose of BEA?
The purpose of the break-even analysis formula is to calculate the amount of sales that equates revenues to expenses and the amount
of excess revenues, also known as profits, after the fixed and variable costs are met. The break-even analysis lets you determine what
you need to sell, monthly or annually, to cover your costs of doing business—your break-even point. There are many different ways
to use this concept.

What is Break-Even Point (BEP)?

The breakeven point is the level of production at which the costs of production equal the revenues for a product. It is the
production level where total revenues equals total expenses. In other words, the break-even point is where a company produces
the same amount of revenues as expenses either during a manufacturing process or an accounting period. Since revenues equal
expenses, the net income for the period will be zero. Break-even point analysis is a measurement system that calculates the margin
of safety

What Is Margin of Safety?

The difference in volume from the expected level of sales to the break-even point is called the margin of safety (MOS).
If actual sales are 6,000 units and break-even point is 5,000 units, the margin of safety is 1,000 units (6,000 - 5,000).
If actual sales are $120,000 and the break-even point is $100,000, the margin of safety is $20,000 ($120,000 - $100,000).

Break Even Analysis components

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

Fixed costs
A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. Fixed
costs are expenses that have to be paid by a company, independent of any specific business activities. In general, companies can
have two types of costs, fixed costs or variable costs, which together result in their total costs.

Variable costs
Variable costs are costs that change in direct relation to the volume of production. Variable costs increase or decrease depending
on a company's production volume; they rise as production increases and fall as production decreases. 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.
Therefore, these costs vary every month. Variable cost can be contrasted with fixed cost.

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 organization 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 Point Graph

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