## Break Even Analysis

**Meaning**

One of the important indicators of success of the start-up company is the time from starting the business till the moment when revenues of product sales equals the total costs associated with the sale of product – it is also called break-even point. In other words *profit = 0*. Breakeven analysis is accounting tool to help plan and control the business operations.

Break-even point represents the volume of business, where company’s total revenues (money coming into a business) are equal to its total expenses (total costs). In its simplest form, breakeven analysis provides insight into whether or not revenue from a product or service has the ability to cover the relevant costs of production of that product or service.

** TOTAL REVENUE = TOTAL COST**

Break-even analysis is based on categorizing production costs between those which are:

Ø VARIABLE cost that do vary with the number of units produced and sold (raw materials, fuel, direct labor, revenue-related costs), and those that are

Ø FIXED costs that don’t vary with the number of units produced and sold (salaries, rent and rates, depreciation, marketing costs, administration costs, R&R, insurance)

**Need**

**importance & limitation**

**Computation –**

**profit volume ratio**

** break even point**

To calculate break-even point we need to know following information:

- · The price that the company is charging,
- · variable costs (direct costs) of each unit and
- · fixed costs (or indirect costs/overheads).

TR = Total revenue

P = Selling price

Q = Number of units sold

TC = Total costs

F = Fixed costs

V = Variable costs

FC = Total fixed costs

VC = Total variable costs

TR = P × Q

VC = C × Q

TC = FC + VC

TR − TC = profit

Because there is **no profit**

** **

TR − TC = 0

P × Q − (F + V × Q) = 0

Q = F × (P − V).

It is quicker to use the following formula:

** BREAK EVEN POINT = FC/ (P – VC)**

**Note: **the higher the fixed costs are the higher is the break-even point!

**Example of Break-even analysis diagram**

**Why do companies want (and need) to know the break-even point?**

- · First, in order to even know what volume of operations allows them to operate without loss, or, what is the volume of business in which the loss breaks in the profits;

- · further in order to determine, if they sufficient capacity for this volume of business

- · and ultimately therefore, to find out if there is sufficient market for such volume of operations

**Margin of safety**

**estimate sales for requires profit **

**estimated profit for given sales.**