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Break Even Analysis Cost Volume-Profit Analysis and Breakeven

Owners and managers need to be familiar with tools and techniques that aid them in making short-term and long-term decisions. One good tool that helps in making decisions is known as Cost-Volume-Profit Relationships. Cost-Volume-Profit Analysis deals with how costs and profits change with a change in volume. t analy!es the effects on profits of changes in such factors as variable costs" fi#ed costs" selling prices" volume" and the mi# of products sold. Break-Even Analysis" one of the tools of CostVolume-Profit Analysis" determines the break-even sales which is the units and$or sales dollars where total sales equals total costs %e#penses&. 'ome e#amples of decisions where Cost-Volume-Profit analysis can provide help are( )hat price%s& should we charge for our products or services * +ow many units of a product should we produce * 'hould we spend more on advertising * 'hould we add or delete a product line * 'hould we accept or decline a special order * )hat sales mi# %different products& should we strive for * )hat is the effect of a change to a different raw material supplier * 'hould we increase or decrease our work force * +ow should we make our products *

'imple ,reakeven Analysis


-wo important definitions used in break-even analysis are( Variable Costs %.#penses& are costs that change directly in proportion to changes in activity %volume&. /i#ed Costs %.#penses& are costs that remain constant %fi#ed& for a given time period despite wide fluctuations in activity %volume&.

)e0ll use /lee1arket ,argains as our simple e#ample to illustrate break-even analysis. /lee1arket ,argains information" costs" and prices( 'ells cartoon watches that have a cost of 234.44 %variable cost-e#pense& All unsold watches may be returned to the supplier ,ooth rental costs 2 344.44 for the day %fi#ed cost-e#pense& 'elling price of the watches is 254.44

)e will use the above information to calculate the number of watches %units& and the sales dollars we need in order for our flea market business to break even for the day. -here are three methods that can be used to calculate our break even point( .quation 1ethod Contribution 1argin 1ethod 6raphic 1ethod

Basic Breakeven Equation Method 'ales 7 Variable .#penses 8 /i#ed .#penses 8 Profit 9et0s adopt this equation and calculate the number of watches that we must sell in order to breakeven. -he basic breakeven equation becomes( :nit 'elling Price ; <umber of :nits 'old 7%:nit Cost ; <umber Of :nits 'old& 8 /i#ed Costs 8 Profit 9et ; 7 <umber of units %watches& that need to be sold to break even 254.44; 7 234.44; 8 2344.44 8 4 234.44; 7 2344.44 8 4 X !"#$$%$$ & $' ( "#$%$$ ; 7 34 units %watches& ,reakeven <umber of )atches is 34 )e can easily calulate the dollar sales necessary to break even by multiplying the sales price of the watches by the break even number of watches. ,reak .ven 'ales =ollars 7 34 %watches& # 254.44$per watch ,reak .ven 'ales =ollars 7 2544.44 34 watches > 254.44 2544.44 Sales of Watches Cost of Watches 34 watches > 234.44 344.44 Booth Rental (Fi ed Cost! 344.44 Profit 24.44 Contri)ution Mar*in Method -he +nit Contribution 1argin is the difference between your product0s unit selling price and its unit variable cost. :nit Contribution 1argin 7 :nit 'ales Price - :nit Variable Cost :nit Contribution 1argin %watches& 7 254.44 - ?4.44 :nit Contribution 1argin 7 234.44 ,reakeven Point 7 %/i#ed .#penses 8 =esired Profit& $ :nit Contribution 1argin 9et ; 7 <umber of units %watches& that need to be sold to break even X !"#$$%$$ & $ ' ( "#$%$$

9ook at the highlighted line in the ,asic ,reakeven .quation. t0s the same as the line above. -he contribution margin method is merely a shortcut version of the ,asic ,reakeven .quation 1ethod. ; 7 34 units %watches& @ou can use either method to calculate breakeven units and$or sales dollars. -he choice is a matter of personal preference. )hat if you want to see how many units you need to sell to not Aust breakeven but make a certain amount of profit * f you want to make a profit of 2544.44 from you sale of watches at the flea market all you need to do is include your desired amount of profit in your breakeven calculation. ,reakeven Point 7 %/i#ed .#penses 8 =esired Profit& $ :nit Contribution 1argin ; 7 %2344.44 8 2544.44 & $ 234.44 ; 7 2B44 $ 234.44 ; 7 B4 units %watches& 9et0s do one more thing to check our calculation. )e0ll construct a simple profit and loss statement. B4 watches > 254.44 2C44.44 Sales of Watches Cost of Watches B4 watches > 234.44 B44.44 Booth Rental (Fi ed Cost! 344.44 Profit 2544.44 'ure enough" if we sell B4 watches at the flea market we0ll make a profit of 2544.44. -he term contribution margin may be e#pressed as a total dollar amount" as an amount per unit %as the prior e#ample&" or as a percentage. n our last e#ample :nit Contribution 1argin is :nit 'elling Price less :nit Variable Cost or 254.44 - 234.44 7 234.44 -otal Conribution 1argin is :nits 'old multiplied by the :nit Contribution 1argin B4 watches ; 234.44 7 2B44.44 Percentage Contribution 1argin is the :nit Contribution 1argin $ :nit 'elling Price or 234.44 $ 254.44 7 D4E or .D4

:sing our e#ample where we wanted a profit of 2544.44 on our sale of watches" we can calculate the ,ales -ollars <eeded with another variation of the ,reakeven .quation. 'ales =ollars <eeded 7 %/i#ed .#penses 8 =esired Profit& $ Contribution 1argin Fatio 'ales =ollars <eeded 7 %2344.44 8 2544.44& $ .D4 'ales =ollars <eeded 7 2C44.44 .raphical Approach

'ince some of the sites recommend later for further study have a detailed discussion of the graphical approach" 0m only going to provide you with a brief description. -he graphical approach has an ;-a#is %hori!ontal& that repesents :nits %volume& and a @-a#is %vertical& that represents =ollars and contains lines for( 'ales Variable Costs %.#penses& -otal Costs %.#penses&

-he point on the graph where the 'ales and -otal Cost %.#pense& 9ines intersect is the breakeven point. Another graph that is often used to compare how alternatives on pricing" variable costs" or fi#ed costs may affect net income %profit& as volume changes is called a P$V Chart or Profit-Volume 6raph. /ther Comments Our simple /lea 1arket e#ample assumed we0re only selling one product. 1ost businesses sell many products and use techniques that factor their sales mi# into the breakeven analysis. )e have Aust touched on how to use break-even anlysis. t may appear that you have to be good at math and equations" but all you really need is to become familiar with the the tool" learn how to classify cost as fi#ed and variable" and use a computer program or spreadsheet template that automates the calculations" presents the results" and even provides graphs if desired. f you would like to learn more about Cost-Volume-Profit Felationships and ,reak.ven Analysis and build on the basics that have presented recommend that you visit the following sites( Gnowledge=ynamics luckily ran across this site by accident. -his site is Aust too *ood to miss if you really want to learn how to use ,reak-.ven Analysis. -heir ,reak-.ven Analysis 'imulation is a new" revolutionary type of e-9earning course. :nlike other e-learning courses" you will learn-by-doing in a realistic" yet risk-free environment. After completing their 'imulation" you will be able to( o =erive and e#plain the ,reak-.ven formula o Classify various costs as either fi#ed or variable o Calculate the ,reak-.ven volume and date for a given venture o .#plain the impact of various manufacturing and marketing decisions ,u!6ate 6ood introduction to breakeven anlysis and how this tool can help your business in making decisions. /i#ed and Variable Costs CC+ ,usiness -oolkit ,efore you can use cost$volume$profit analysis to help you evaluate your business0s operations" you need to get a handle on the fi#ed costs of your business" as compared to your variable costs.

)eatherhead 'chool of 1anagement .#cellent review of break-even terminology. Also includes e#amples and an online break-even calculator and graphics display. Vanderbilt :niversity %6raphical Approach& -his material covers the development of the break-even chart" the use of profit graphs %with illustrations of how cost and price changes impact profits&" and a discussion of how you can develop a spreadsheet to generate profit graphs and compute break-even points. ,i!ni!portal 'imple online break even analysis calculator designed to demonstrate how many units of your product must be sold to make a profit. +,' ,reak .ven Analysis -oolkit 9ink Courtesy of )achowic!0s )eb )orld %Hohn )achowic!-Professor of /inance :niversity of -ennesee& and +arvard ,usiness 'chool. =ownloadable interactive workbook from the +,' -oolkit helps calculate a break-even point or target-profit level based on the fi#ed costs" variable costs" and unit price of the product or service being analy!ed. .stimating ,reakeven 'ales for @our 'mall ,usiness P=/ =ocument courtesy of Purdue :niversity .#tension ,reakeven Analysis CC+ ,usiness OwnerIs -oolkit A tool for management decision making that has grown out of cost$volume$profit. 'ales Volume ,reakeven Analysis CC+ /inancial Planning -oolkit J /ind out how many and at what price you must sell your product in order to make a profit. ,reak-.ven Point Analysis Provided by bi!bound.com -he ,reak-.ven Calculator Provided by the )eatherhead Connection" the )eatherhead 'chool of 1anagement" and Case )estern Feserve :niversity -he ,reak-.ven Analysis 1odule illustrates the fundamentals of break-even analysis" a time-tested technique that is often used by companies and consultants to evaluate alternative business strategies and tactics. t contains a basic break-even calculator and one sample e#ercise. t is designed to be used with data from any case study or real-world situation for which breakeven analysis is appropriate. 1ore sophisticated variations of break-even analysis are used by companies around the world" but the principles remain the same as are illustrated here.

recommend you take the time and visit all the recommended sites in order to gain some knowledge that you can apply to some of your o0n business decisions.