## 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.

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