Break Even Analysis

Tags

finance

Break even point is the [see page 5, point] at which total revenue equals total cost, I.E. no loss or profit has been made. Break even analysis is the calculation of this point using total costs.

We define

• Total revenues as \(Total Costs + Profit = (Fixed Costs + Varaible Costs) + Profits\)
• Unit Contribution Margin = \(unit Selling Price - Unit Variable Cost\)
• Contribution Margin Ratio = \(\frac{Unit Contribution Margin}{Unit Selling Price}\)

Note: Number of units sold AKA output volume (or just volume).

If we substitute the number of units sold into the above equation, we can [see page 3, re-arrange] to find this quantity given an expected total revenue \(Q\). If we set \(Q = 0\) then we can find the break even point.

We can repurposed the above equation to calculate the units needed to reach a target [see page 15, profit].

A larger fixed cost generally makes a company more dependent on sales. A slight reduction in the cost of each unit at the expense of a larger fixed price can lead to failures to meet the (fixed price) break even point when the number of sold units decreases.

See [see page 22, Advantages & Disadvantages].

[see page 20, Applications]

1. Initial price setting. The initial price of a new project will generally have more fixed costs and lower sales volume so they generally set a higher initial price.
2. Business plan. Expected sales targets and margin of safety is an indication of business risk.
3. Marketing. Discounts should be given based on extra units to maintain profits.