Break-Even Analysis
BeginnerBreak-even analysis works out the level of sales at which a business's total revenue exactly covers its total costs, so it makes neither a profit nor a loss.
Costs come in two kinds. Fixed costs, such as rent and salaries, stay the same whatever the sales volume. Variable costs, such as materials, rise with each unit sold. Each sale contributes its selling price minus its variable cost towards covering the fixed costs; this is called the contribution per unit.
The break-even point is reached when total contributions equal fixed costs. Suppose a business has fixed costs of 30,000 a month, sells its product for 50 and spends 30 per unit on materials and delivery. Each unit contributes 20. The business needs to sell 1,500 units a month to break even. Every unit sold beyond that adds 20 of profit.
Break-even analysis helps with pricing, planning and judging risk. It shows how much sales could fall before the business starts losing money, and how changes in price or costs affect profitability.
The method is a simplification. It assumes prices and variable costs per unit stay constant and that all output is sold, which may not hold in practice.
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