What is Break Even Analysis?

Break Even Analysis is a risk evaluation method of determining the level of output at which the cost of the production will be equal to the revenue generated from sales to cover fixed & variable costs, and make the business profitable.

Break Even Analysis is often used in different contexts. For example, businesses use it to set sales targets through Profit-Volume charting. Stock market traders use it to determine the level at which they can recover the original value of their underlying asset and avoid losses. Homeowners use it to offset their net purchase price (which includes maintenance charges, and interest on mortgages) while selling their homes.

What are the Components of Break Even Point Analysis?

Now that we’ve discussed the Break Even Analysis meaning, let us discuss its components.

1. Fixed Costs

Fixed Costs are also called Overhead Costs. These costs remain constant, regardless of the changes in the volume of production. In simple words, businesses have to bear fixed costs even if the production drops to zero. Examples of fixed costs include energy costs, machinery costs, rent of premises, mortgages, insurance premiums, and taxes payable to the Government.

2. Variable Costs

Unlike Fixed Costs, Variable Costs are fluctuating in nature. They increase or decrease the per the volume of production. Examples of variable cost includes raw material costs, fuel costs, product packaging expenditures, and the cost of procuring production materials. Differentiating variable costs from fixed costs is important for businesses for better decision-making.

3. Selling Price

Selling Price is the amount that the company charges for its products and services. Setting the right selling price is a complex yet crucial process. In today’s highly competitive business environment, businesses are leveraging BI tools to uncover new trends & patterns, analyze customer behaviors, and build successful marketing campaigns.

4. Contribution Margin

Contribution Margin is an integral component of the Break Even Analysis that denotes how much revenue is required to be generated to cover fixed costs and contribute to business profits. It is calculated by subtracting variable costs from the selling price. For example, if the price of a television is Rs. 40,000 and the variable cost (i.e. cost of raw materials, labor, etc.) is Rs. 15,000, the contribution margin is Rs. 25,000.

5. Break Even Point

The Break Even Point is the level of production at which the production cost equals the revenue generated from the sale. In other words, it is a “No Profit – No Loss” point wherein the business neither gains profits nor losses. Break Even Point analysis helps businesses identify the Break Even Point to set marketing targets, optimize product pricing, and uncover hidden expenditures.

Break Even Analysis Formula

Now that we’ve covered the Break Even Analysis explanation, let us move to the Break Even Analysis formula.

Break Even Analysis Formula:

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