Break-even Analysis
1.5 Break-even Analysis
Break-even analysis helps businesses determine the level of sales required to cover all costs. It identifies the point where total revenue equals total cost, meaning the business is making no profit and no loss — the break-even point.
Types of Costs
Fixed Costs: Expenses that do not change with production level (rent, salaries, insurance, machinery depreciation). Even if production stops, these costs still exist.
Variable Costs: Costs that change depending on how much is produced (raw materials, packaging, direct labor wages, electricity). If production increases, variable costs also increase.
Revenue = Selling Price × Quantity Sold
Break-even Formula: Break-even quantity = Fixed Costs ÷ (Selling Price – Variable Cost per Unit)
Contribution per unit = Selling price – Variable cost per unit — how much each unit sold contributes toward covering fixed costs and generating profit.
Importance: Plan production levels, set appropriate prices, understand cost structures, evaluate business risks, make investment decisions.
Limitations: Assumes costs remain constant; assumes all goods produced are sold; does not consider market changes; simplifies real business situations.