Financial Modeling Tutorials
- Excel Modeling
- Financial Functions in Excel
- Sensitivity Analysis in Excel
- Sensitivity Analysis
- Capital Budgeting Techniques
- Time Value of Money
- Future Value Formula
- Present Value Factor
- Perpetuity Formula
- Present Value vs Future Value
- Annuity vs Pension
- Present Value of an Annuity
- Doubling Time Formula
- Annuity Formula
- Present Value of an Annuity Formula
- Future Value of Annuity Due Formula
- Maturity Value
- Annuity vs Perpetuity
- Annuity vs Lump Sum
- Deferred Annuity Formula
- Internal Rate of Return (IRR)
- IRR Examples (Internal Rate of Return)
- NPV vs XNPV
- NPV vs IRR
- NPV Formula
- NPV Profile
- NPV Examples
- Advantages and Disadvantages of NPV
- Mutually Exclusive Projects
- PV vs NPV
- IRR vs ROI
- Break Even Point
- Break Even Analysis
- Breakeven Analysis Examples
- Break Even Chart
- Benefit Cost Ratio
- Payback Period & Discounted Payback Period
- Payback period Formula
- Discounted Payback Period Formula
- Payback Period Advantages and Disadvantages
- Profitability Index
- Feasibility Study Examples
- Cash Burn Rate
- Interest Formula
- Simple Interest
- Simple Interest vs Compound Interest
- Simple Interest Formula
- CAGR Formula (Compounded Annual Growth Rate)
- Growth Rate Formula
- Effective Interest Rate
- Loan Amortization Schedule
- Mortgage Formula
- Loan Principal Amount
- Interest Rate Formula
- Rate of Return Formula
- Effective Annual Rate
- Effective Annual Rate Formula (EAR)
- Compounding Formula
- Compound Interest
- Compound Interest Examples
- Daily Compound Interest
- Monthly Compound Interest Formula
- Discount Rate vs Interest Rate
- Discounting Formula
- Rule of 72
- Geometric Mean Return
- Geometric Mean vs Arithmetic Mean
- Real Rate of Return Formula
- Continuous compounding Formula
- Weighted average Formula
- Average Formula
- EWMA (Exponentially Weighted Moving Average)
- Average Rate of Return Formula
- Mean Formula
- Mean Examples
- Population Mean Formula
- Weighted Mean Formula
- Harmonic Mean Formula
- Median Formula in Statistics
- Range Formula
- Outlier Formula
- Decile Formula
- Midrange Formula
- Quartile Deviation
- Expected Value Formula
- Exponential Growth Formula
- Margin of Error Formula
- Decrease Percentage Formula
- Relative Change
- Percent Error Formula
- Holding Period Return Formula
- Cost Benefit Analysis
- Cost Benefit Analysis Examples
- Cost Volume Profit Analysis
- Opportunity Cost Formula
- Opportunity Cost Examples
- APR vs APY
- Mortgage APR vs Interest Rate
- Normal Distribution Formula
- Standard Normal Distribution Formula
- Normalization Formula
- Bell Curve
- T Distribution Formula
- Regression Formula
- Regression Analysis Formula
- Multiple Regression Formula
- Correlation Coefficient Formula
- Correlation Formula
- Correlation Examples
- Coefficient of Determination
- Population Variance Formula
- Covariance Formula
- Coefficient of Variation Formula
- Sample Standard Deviation Formula
- Relative Standard Deviation Formula
- Standard Deviation Formula
- Standard Deviation Examples
- Effect Size
- Sample Size Formula
- Volatility Formula
- Binomial Distribution Formula
- Hypergeometric Distribution
- Exponential Distribution
- Central Limit Theorem
- Poisson Distribution
- Central Tendency
- Hypothesis Testing
- Gini Coefficient
- Quartile Formula
- P Value Formula
- Skewness Formula
- R Squared Formula
- Adjusted R Squared
- Regression vs ANOVA
- Z Test Formula
- Z Score Formula
- Z Test vs T Test
- F-Test Formula
- Quantitative Research
- Histogram Examples
What is Break Even Analysis?
Break-even analysis determines what level of sales is required to cover the total cost of business (Fixed as well as variable cost). It shows us how to calculate the point or juncture when a company would start to make the profit.
Types of Costs in Break-Even Analysis
- Fixed Cost – It is also known as the overhead cost. The commitment of these costs arise once it is decided to start an economic activity and it is based on the level of production but not at all on the quantity of production. Some common fixed costs are taxes, interests, salaries, depreciation, rent, permanent labor cost, etc. These costs have no linkage with the production or sales quantity.
- Variable Cost – These are the cost that varies directly with the level of production. These are not committed cost and will occur only if the production takes place. Some common variable costs are raw material cost, direct labor or casual labor, fuel, packaging cost, etc.
Break Even Analysis Formulas
There are two approaches to calculate the break-even point. One can be in quantity termed as break-even quantity and other is sales which are termed as break-even sales.
In the first approach, we have to divide the fixed cost by contribution per unit i.e.
Break Even Point (Qty) = Total Fixed Cost / Contribution per Unit
- Where, Contribution per Unit = Selling Price per Unit – Variable Cost per Unit
In the second approach, we have to divide the fixed cost by contribution to sales ratio or profit-volume ratio i.e.
Break Even Sales (Rs) = Total Fixed Cost / Contribution Margin Ratio,
4.9 (1,067 ratings)
- Where Contribution Margin Ratio = Contribution per Unit / Selling Price per Unit
Example of Break-Even Analysis
Let us understand the example of Break-Even Analysis.
Suppose XYZ Ltd is expecting of selling 10,000 units at a price of $10 each. The variable cost associated with the product is $5 per unit and the fixed cost is coming $15,000 per year. Do the break-even analysis for the given case.
Use the following data for the calculation of break-even analysis
The break-even situation for the given case can be calculated in either quantity terms or in dollar terms.
Calculation of Break Even Point can be done as follows –
To calculate the Break Even Point (Quantity) for which we have to divide the total fixed cost by the contribution per unit.
- Here, Selling Price per unit = $10
- Variable Cost per unit = $5
- So, Contribution per unit = $10 – $5 = $5
- Hence Break Even Point (Quantity) = $15000 / $5 units
Break Even Point (Quantity) = 3000 Units
It means by selling up to 3000 units XYZ Ltd will be in no loss and no profit situation and will overcome its fixed cost only. Selling quantity beyond 3000 will help in earning profit which will be equal to the contribution per unit for every additional unit sold beyond 3000.
Calculation of Break Even Sales can be done as follows –
To calculate the Break Even Sales ($) for which we will divide the total fixed cost by the contribution margin ratio.
- Here contribution per unit = $5
- Selling price per unit = $10
- So, contribution margin ratio = $5 / $10 = 0.5
- Hence Break Even Sales ($) = $15000 / 0.5
Break Even Sales ($)= $30,000
It means by selling up to sales value of $30,000, XYZ Ltd will be in breakeven point and will overcome its fixed cost only and will earn profit equal to the sales value beyond $30,000 equal to contribution margin * Sales value beyond $30,000.
Advantages of Break-Even Analysis
- Catches Missing Expenses: One has to figure out all the committed cost as well as the variable cost while reviewing the financial commitment to figure out the breakeven point and in this way some missing expenses which are caught out.
- Set Targets for Revenue: As and when the break-even analysis is complete, one comes to know their projected sales revenue so as to earn the projected profit and it also helps sales teams to set more concrete goals.
- Powerful Decision Making: As the top management is having more defined data, it will help them in good decision making to expand the business or taking any new contract by offering a good minimum price by considering the sunk cost.
Disadvantages of Break-Even Analysis
- Unrealistic assumptions as the selling price of a product can’t be the same at different sales level and some fixed costs might vary with the output.
- Sales can’t exactly be the same as to that of production. There can be some closing stock or wastage as well.
- Businesses selling more than one product: It will be tough to analyze break even as apportioning of fixed cost among two products will be challenging one.
- Variable product or services cost will not always remain the same. As the level of output will increase one’s bargaining power to procure material or service will also increase.
- It is a planning aid and not a decision-making tool.
- Break-even analysis tells us at what level an investment has to reach so that it can recover its initial outlay.
- It is also considered as a measure for the margin of safety.
- It is used broadly be it the case of stock and options trading or corporate budgeting for various projects.
Break-even analysis is very important for any organization so that it can know its overall ability in generating profit. Suppose for any company if its break level is coming near to the maximum sales level which the company could reach then it is impractical for that company to earn profit even in the all positive scenario. Therefore, it is the responsibility of the management that it should monitor the organization breakeven point constantly as it helps in cost saving and resulting in a decrease of the breakeven point.
This has been a guide to Break Even Analysis and its definition. Here we discuss the break-even analysis formula along with calculation examples, advantages, and disadvantages. You can learn more about accounting from following articles –