It is the point at which total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss.
One of the most common tools used in evaluating the economic feasibility of a new enterprise or product is the break-even analysis. The break-even point is the point at which revenue is exactly equal to costs. At this point, no profit is made and no losses are incurred. The break-even point can be expressed in terms of unit sales or dollar sales. That is, the break-even units indicate the level of sales that are required to cover costs. Sales above that number result in profit and sales below that number result in a loss. The break-even sales indicates the dollars of gross sales required to break-even.
Break even point (for output) = fixed cost / contribution per unit
Contribution per unit= selling price (p.u) - variable cost (p.u)
Break even point (for sales) = fixed cost / contribution (pu) * Selling price (pu)
Fixed Costs
Fixed costs are those business costs that are not directly related to the level of production or output. i-e, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same.
Examples are;
Admin expenses
Rent of office building
Marketing and research cost
etc.
Variable Costs
Variable costs are those costs which vary directly with the level of output.
Examples are;
Manufacturing expenses i-e labour cost, raw material cost etc
Assumptions are:
It assumes that fixed costs (FC) are constant.
It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales.
It assumes that the quantity of goods produced is equal to the quantity of goods sold
Illustration
Abc limited has following monthly data. calculate break even point.
Average Selling price per unit $ 10
Average Variable cost per unit $ 6
Fixed cost (Estimated) $ 20,000
Break Even analysis
Monthly Sales (units) 5,000
Monthly Sales ($) 50,000
Therefore, no profits are made from the sale of this product until more than 5,000 units are sold or more than $ 50,000 in gross sales is generated.
Break-even analysis can be very helpful in the evaluation of a new venture. In most instances, success takes time.Many new enterprises and products actually operate at a loss (at a point below break-even) in the early stages of development. Knowing the price or volume necessary to break-even is critical to evaluating the time-frame in which losses are permissible. The break-even is also an excellent benchmark by which a company’s short-termgoals can be measured/tracked. Break-even analysis mandates that costs be analyzed. It also keeps a focus
connection between production and marketing.
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