Breakeven analysis is a financial tool that helps businesses to determine the point at which their total revenue equals their total costs, resulting in neither a profit nor a loss. In other words, it is the point at which the business has covered all its expenses and has not yet made a profit.
Breakeven analysis is important for businesses because it helps them to determine the minimum level of sales needed to cover their costs and avoid a loss. This information is critical for businesses when making decisions regarding pricing, production levels, and sales targets.
The breakeven point is calculated by dividing the fixed costs by the difference between the selling price per unit and the variable cost per unit. The formula for breakeven analysis is:
Breakeven Point = Fixed costs / (Selling price per unit – Variable cost per unit)
Fixed costs refer to expenses that remain constant regardless of the level of production or sales. Examples of fixed costs include rent, salaries, and insurance.
Variable costs, on the other hand, are expenses that vary with the level of production or sales. Examples of variable costs include raw materials, labor, and commissions.
The breakeven point can also be calculated using the contribution margin per unit, which is the selling price per unit minus the variable cost per unit. The formula for breakeven analysis using contribution margin is:
Breakeven point = Fixed costs / Contribution margin per unit
The contribution margin represents the portion of the selling price per unit that contributes to covering the fixed costs and generating profit. The higher the contribution margin, the lower the breakeven point.
Breakeven analysis can also be used to determine the impact of changes in selling price or variable cost on the breakeven point. For example, if the selling price per unit is increased, the breakeven point will decrease, meaning that the business needs to sell fewer units to cover its fixed costs. Similarly, if the variable cost per unit is decreased, the breakeven point will also decrease.
Breakeven analysis is a useful tool for businesses to determine their minimum level of sales needed to cover their costs and avoid a loss. By calculating the breakeven point and understanding the impact of changes in selling price or variable cost on the breakeven point, businesses can make informed decisions regarding pricing, production levels, and sales targets.
Algebraic and Graphic Methods
The algebraic method involves using the breakeven formula to calculate the breakeven point. The formula is:
Breakeven point = Fixed costs / (Selling price per unit – Variable cost per unit)
To use the algebraic method, you need to know the fixed costs, selling price per unit, and variable cost per unit. Once you have this information, you can plug it into the formula to calculate the breakeven point.
For example, let’s say your fixed costs are $10,000, selling price per unit is $50, and variable cost per unit is $30. Using the formula, the breakeven point would be:
Breakeven point = $10,000 / ($50 – $30) = 400 units
This means that you need to sell 400 units of your product to cover your fixed costs and break even.
The graphic method involves using a breakeven chart to visually represent the breakeven point. The chart shows the relationship between total revenue, total costs, and quantity sold.
To create a breakeven chart, you need to plot your fixed costs, variable costs, and total costs as straight lines on the graph. Then, you can plot your total revenue as a curved line that intersects the total cost line at the breakeven point.