Break-Even Analysis

Lesson:

Have you ever wanted to go into business and earn zero profit?

Many businesss owners do. Getting to the point at which no profit is made is called the break-even point.

Getting to this point is important, because it's where the company can pay all of its costs and continue to exist without burning through savings.

Once a firm has reached the break-even point, any improvement will push the company into profitability.

So how do we figure out what this point is?

We know it's when our costs are equal to our profits. Of course, we can break our costs into two parts: fixed and variable.

So we can say that our fixed costs plus our variable costs are equal to our profits.

You're a cost accountant looking through your firm's records.

This is what you've been told:

  • It has $790.00 in fixed costs.
  • The firm sells each pen for $14.00.
  • Each pen costs the company $6.00 to produce
How many items does the firm need to sell to break even?

Answer:

  • The firm must sell 98.75 units.

Explanation:

  1. We need to calculate the contribution margin (how much higher the price is over the variable cost of each item).
    CONTRIBUTION MARGIN = PRICE - VARIABLE COST
  2. Let's fill the numbers in
    $8.00 = $14.00 - $6.00
  3. We need to see how many sales we'd have to have to pay for the fixed costs of the company.
    NUMBER OF SALES = FIXED COST / CONTRIBUTION MARGIN
  4. Let's fill the numbers in
    98.75 = $790.00 / $8.00
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