## 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.

Next Up

## 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 managementâ€™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. ### Profit Range

Profit Range refers to the range of prices which return a profit ...
2. ### Breakeven Tax Rate

The breakeven tax rate is the tax rate at which it would neither ...
3. ### Unit Cost

Unit cost is the cost incurred by a company to produce, store ...
4. ### Fixed Cost

A fixed cost is an expense that remains the same regardless of ...
5. ### Variable Cost Ratio

The variable cost ratio compares costs, which fluctuate depending ...
6. ### Operating Leverage

Operating leverage is the degree to which a firm or project can ...
Related Articles
1. Personal Finance

### Tips for Answering Series 7 Options Questions

We'll show you how to ace the largest and most difficult section of the Series 7.
2. Managing Wealth

### Whatâ€™s a Good Profit Margin for a New Business?

Surprisingly, the younger your company is, the better its numbers may look when it comes to your profit margin.

### How Gross Margin Can Make or Break Your Startup

Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.

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

6. Retirement

### 401(k) Contribution Limits in 2018-19

Find out what the contribution limits are for 401(k) retirement savings plans in 2019, including individual, employer, and aggregate limits.
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 gross margin and contribution margin differ?

Gross margin and the contribution margin are metrics used to measure profitability, but each uses a different method. Read Answer >>
3. ### What Is Operating Margin vs. Contribution Margin?

Understand the difference between two measures of profitability, operating margin and contribution margin, and the purpose ... Read Answer >>
4. ### Gross Margin vs Operating Margin: What the difference?

Understand the difference between gross margin and operating margin in relation to evaluating a company's overall profitability ... Read Answer >>
5. ### How do fixed costs and variable costs affect gross profit?

Learn about the differences between fixed and variable costs and find out how they affect the calculation of gross profit ... Read Answer >>
6. ### Profit margin versus operating margin: What's the difference?

There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>