Break-Even Analysis

Break-even analysis is a financial tool which helps determine at what level of sales, a business will cover all its costs and begin to make profit.

Fixed costs are costs that do not change with the level of output such as rent or salaries for permanent staff.
Variable costs vary directly with the level of output such as raw materials.
Sales revenue is the income received from selling goods and services.
The break-even point is the point where total revenues equal total costs - both fixed and variable.

The break-even point (in units) is calculated using the formula: Fixed Costs / Contribution Margin per unit where the Contribution Margin per unit is the selling price per unit minus the variable cost per unit.
Alternatively, the break-even point can be presented in monetary terms using the formula: Fixed Costs / Contribution Margin Ratio where the Contribution Margin Ratio is the Contribution Margin per unit divided by the selling price per unit.

A break-even chart visually represents the different levels of output/sales volume and the associated costs and revenues.
The total cost curve represents the sum of fixed and variable costs at a given level of output.
The total revenue curve represents the money generated from selling a certain quantity of products.
Where the total revenue curve intersects with the total cost curve shows the break-even point.

It helps determine the minimum output needed to avoid losses.
It aids in understanding and managing the impact of cost changes on profitability.
It informs pricing strategy by providing insight on how price changes affect the break-even point.
It aids in decision making concerning product mix - understanding which products contribute more to covering fixed costs can inform decisions about marketing, production and investment.

It assumes all units produced are sold, which might not always be the case.
It assumes that costs and revenues are linear, which can oversimplify real-world situations.
It does not account for changes in market conditions such as fluctuations in demand or competition.
It ignores the impact of economies of scale which might cause varying costs over different volumes of output.