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Break-Even Analysis

Lesson
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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.

Question
Your boss isn't an accountant and needs your help to understand your firm's operations.

This is what you've been told:

  • The firm expects to sell 154.33 units.
  • Each tire costs the company $8.00 to produce
  • The firm sells each tire for $14.00.
How much can the company spend on fixed costs and still break even?
Answer
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👉 Answer:

  • The firm will spend $926.00 in fixed costs.

👩‍🎓 This is how we solve it:

  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
    $6.00 = $14.00 - $8.00
  3. We need to see how much money is generated from sales. This must be equal to our fixed costs.
    FIXED COST = NUMBER OF SALES * CONTRIBUTION MARGIN
  4. Let's fill the numbers in
    $926.00 = 154.33 * $6.00
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