Loading the player...

What is a 'Break-Even Analysis'

Break-even analysis entails the calculation and examination of the margin of safety for an entity based on the revenues collected and associated costs. Analyzing different price levels relating to various levels of demand, an entity uses break-even analysis to determine what level of sales are needed to cover total fixed costs. A demand-side analysis would give a seller greater insight regarding selling capabilities.

BREAKING DOWN 'Break-Even Analysis'

Break-even analysis is useful in the determination of the level of production or in a targeted desired sales mix. The analysis is for management’s use only as the metric and calculations are often not required to be disclosed to external sources such as investors, regulators or financial institutions. Break-even analysis looks at the level of fixed costs relative to the profit earned by each additional unit produced and sold. In general, a company with lower fixed costs will have a lower break-even point of sale. For example, a company with $0 of fixed costs will automatically have broken even upon the sale of the first product assuming variable costs do not exceed sales revenue. However, the accumulation of variable costs will limit the leverage of the company as these expenses are incurred for each item sold.

Contribution Margin

The concept of break-even analysis deals with the contribution margin of a product. The contribution margin is the excess between the selling price of the good and total variable costs. For example, if a product sells for $100, total fixed costs are $25 per product and total variable costs are $60 per product, the product has a contribution margin of the product is $40 ($100 - $60). This $40 reflects the amount of revenue collected to cover fixed costs and be retained as net profit. Fixed costs are not considered in calculating the contribution margin.

Formulas for Break-Even Analysis

The calculation of break-even analysis may be performed using two formulas. First, the total fixed costs are divided the unit contribution margin. In the example above, assume total company fixed costs are $20,000. With a contribution margin of $40, the break-even point is 500 units ($20,000 divided by $40). Upon the sale of 500 units, all fixed costs will be paid for, and the company will report a net profit or loss of $0.

Alternatively, the break-even point in sales dollars is calculated by dividing total fixed costs by the contribution margin ratio. The contribution margin ratio is the contribution margin per unit divided by the sale price. Using the example above, the contribution margin ratio is 40% ($40 contribution margin per unit divided by $100 sale price per unit). Therefore, the break-even point in sales dollars is $50,000 ($20,000 total fixed costs divided by 40%). This figured may be confirmed as the break-even in units (500) multiplied by the sale price ($100) equals $50,000.

RELATED TERMS
  1. Unit Sales

    Unit sales are a measure of the total sales that a firm earns ...
  2. Operating Leverage

    Operating leverage is a measurement of the degree to which a ...
  3. Breakeven Yield

    The breakeven yield is the yield required to cover the cost of ...
  4. Marginal Cost Of Production

    Marginal cost of production is the change in total cost that ...
  5. Variable Cost

    A variable cost is a corporate expense that changes in proportion ...
  6. Operating Cost

    Operating costs are expenses associated with the maintenance ...
Related Articles
  1. Managing Wealth

    Are Hybrid Cars Really More Economical?

    Find out if buying a hybrid vehicle is more economical than a fuel-based vehicle. Fewer trips to the gas station sounds nice, but you need to do the math.
  2. Personal Finance

    Tips for Answering Series 7 Options Questions

    We'll show you how to ace the largest and most difficult section of this exam.
  3. Investing

    Operating Leverage Captures Relationships

    Find out how fixed and variable costs interact to shed new light on old companies.
  4. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  5. Trading

    Ratio Writing: A High-Volatility Options Strategy

    Selling a greater number of options than you buy profits from a decline back to average levels of implied volatility.
  6. Investing

    What's a Sensitivity Analysis?

    Sensitivity analysis is used in financial modeling to determine how one variable (the target variable) may be affected by changes in another variable (the input variable).
RELATED FAQS
  1. How do you find the break-even point using a payback period?

    Understand what a company's breakeven point is and what its payback period is. Learn why a company would want to track both ... Read Answer >>
  2. How Do Fixed and Variable Costs Affect the Marginal Cost of Production?

    Learn about the marginal cost of production and how it is affected by changes in fixed and variable costs. Read Answer >>
  3. What is the difference between gross profit margin and contribution margin?

    Learn the difference between gross profit margin, an overall profitability metric analysts use, and contribution margin, ... Read Answer >>
  4. How are fixed costs treated in cost accounting?

    Learn how fixed costs and variable costs are used in cost accounting to help a company's management in budgeting and controlling ... Read Answer >>
  5. How do I determine the breakeven point for a short put?

    Learn how to determine the breakeven point for a short put. Shorting puts is appropriate for sophisticated traders who understand ... Read Answer >>
  6. What is the difference between gross margin and contribution margin?

    Understand the difference between the gross margin and the contribution margin, including how they differ in calculation ... Read Answer >>
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center