Finance

Break Even Analysis Formula: And It’s Definition

You will get all the break even analysis formula which you will use to solve equation or problems on the subject matter.

The level and riskiness of a company’s profit are of primary concern to its stockholders and determine the value of the company’s shares. Break even analysis is concerned with the firm underlying cost factors that affect profit.

What is Break Even Analysis

First we have to look at the break even analysis definition before going into the formula.

You can say that break even analysis deals with the relationship of Profits to all costs, both direct and indirect, to pricing policy, and to volume of output. Knowledge of this relationship enables a financial manager to maximize income(profits) by specifying production methods, pricing and output volume. Before going into break even analysis formula, i want you to know that break even analysis is primarily concerned with;

1. How income varies with changes in sales volume.

2. How income varies with changes in costs and prices.

From an examination of the relationship between costs, prices, and income, the financial manager gains insight about the business risk of the firm. Okay then let’s look into the break even analysis formula we have.

Break Even Analysis Formula

Break even analysis 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.

Break Even Analysis Formula

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.

Break Even Analysis Formula

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.

Break Even Analysis Formula

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.

BreakEven Analysis formula


Examples of the break even analysis formula

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

For the break even analysis formula 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).

BreakEven Analysis Formula

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.

Break even analysis formula

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.

BreakEven Analysis formula

These are just examples of the break-even point. You can use these as a template for your business or course work.

We not only will look into the break even analysis formula but also the component and they are below.

Components of Break Even Analysis

Fixed costs
Fixed costs are also called as the overhead cost. 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 no matter how much you sell.

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

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 few expenses. Therefore, if you do a break-even analysis you have to review all your financial commitments to figure out your break-even point. This analysis certainly restricts the number of surprises down the road.
  • 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, your 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.

Posts You May Like

How to calculate time value of money

Time value of money definition

Time value of money formula

That all i have on break even analysis formula, it’s definition and benefits.

 

Written By

Leave a Reply

Your email address will not be published. Required fields are marked *