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.

You've been provided with the following information:

  • The firm has $854.00 in fixed costs.
  • The firm expects to sell 122.00 units.
  • The firm has $15.00 in variable costs.
How much can the firm charge to just break even?

Answer:

  • The price should be $22.00.

Explanation:

  1. We need to calculate the contribution margin (how much higher the price is over the variable cost of each item).
    CONTRIBUTION MARGIN = FIXED COST / NUMBER OF SALES
  2. Let's fill the numbers in
    $7.00 = $854.00 / 122.00
  3. We can figure out the price in relation to the contribution margin.
    PRICE = CONTRIBUTION MARGIN + VARIABLE COST
  4. Let's fill the numbers in
    $22.00 = $7.00 + $15.00
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