Calculating Breakeven

Defining Breakeven

Breakeven is the point where a business’s total revenue matches its total costs. At this point, there is no profit but, equally, no loss.
Fixed costs are costs that do not change despite the level of output. These include items like rent and salaries.
Variable costs fluctuate based on the number of units produced. They include costs such as raw materials and electricity.

Formulas to Calculate Breakeven

The formula for breakeven is: Fixed costs / (Selling price per unit - Variable cost per unit).
The calculation provides the number of units the company needs to sell in order to cover their costs. Until this point, each sale is making a loss.

Using Breakeven Charts

Breakeven charts display the total costs, total revenue, and breakeven point visually, clearly illustrating when the business would start to make a profit.
The x-axis shows output levels, the y-axis shows costs and revenue, the line intersecting denotes the breakeven point.
Everything prior to the breakeven point is a loss, everything after it is a profit.

Applications of Breakeven

Businesses use breakeven to set sales targets, make pricing decisions, and analyse the impact of cost changes.
It helps understand the margin of safety, which is the buffer between actual sales levels and the breakeven point.
It’s a simple tool, but doesn’t take into account factors like competition or changes in demand, so should be used alongside other financial and market analysis.

Limitations of Breakeven Analysis

Assumptions of breakeven analysis can be unrealistic - for example, all units produced are assumed to be sold, and it assumes costs and prices are constant.
Breakeven only provides a snapshot in a specific timeframe. It does not consider the effect of changing circumstances on costs or prices.
It can be misleading for businesses with a diverse product line, as it assumes that the sales mix remains constant.

Remember, understanding the principle of breakeven analysis is as crucial as the calculation itself. Businesses use it as a vital part of planning and forecasting their financial situation.