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What is break-even analysis?

Break-even analysis

In economics, break-even analysis usually refers to a particular point in which total revenue and total cost are equal. Break-even analysis can be used for defining the number of units (quantity) or revenue (sales) necessary to cover the total costs (variable and fixed costs).

The break-even point or BEP shows the sales amount, which is required to cover total costs. It means that all costs are paid and there is neither loss nor profit at this level. 

 Break-even analysis

How break-even analysis works

To define break-even analysis we should understand how it works. The break-even point is one of the most widely used concepts of financial analysis, useful for any type of business. It enables business owners to identify how much output and work is needed to surpass the break-even point and start making profit. 

Uses of break-even analysis differ, as it is widely applied by entrepreneurs, financial planners, managers, accountants and even marketers. The break-even points vary, depending on the type of business. However, it is vitally important for any business to calculate a break-even point, because it will help them to learn how many units (or revenues) they need to cover their costs and eventually become profitable. 

The concept of break-even point

Break-even analysis formula

Break-even analysis is commonly used for determining the level of production or sales necessary to pay for the cost of doing business. It requires the calculation of the break-even point (BEP), which can be done by dividing the total fixed cost of production by the price for an individual unit minus the variable cost of production. Fixed costs remain the same regardless of the number of units sold. 

Methods for break-even analysis consider the level of fixed costs in relation to the earned profit by each additional unit sold or produced. Generally, a company with lower fixed costs will have a lower break-even point. 

Break-even analysis formula

You should also know that sales price per unit minus variable cost per unit is known as the contribution margin per unit. For example, if a pair of shoes has a selling price of $500 and its variable costs are $100 to make this pair, $400 is the contribution margin per unit, which contributes to offsetting the fixed costs. 

Example of break-even analysis

Let’s continue our shoe example, assuming that a small footwear manufacturing business has estimated fixed costs of $100,000, consisting of a lease, property taxes and salaries. The variable cost of producing one pair of shoes is $100 per unit. This pair of shoes is sold for $500. In this case, the break-even point for the business’s pair of shoes will be:

Break even quantity = $100,000/($500-$100) = 250

Therefore, with the current fixed and variable costs and selling price, the footwear maker will need to sell 250 pairs of shoes to break even.

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