Break Even Analysis

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. It can be expressed in terms of unit sales or Rupees 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
indicate the rupees of gross sales required to break-even.
It is important to realize that a company will not necessarily produce a product just because
it is expected to breakeven. Many times, a certain level of profitability or return on investment is
desired. If this objective cannot be reached, which may mean selling a substantial number of units
above break-even, the product may not be produced.
However, the break-even is an excellent tool to help quantify the level of production needed
for a new business or a new product.
Break-even analysis is based on two types of costs: fixed costs and variable costs. Fixed
costs are overhead-type expenses that are constant and do not change as the level of output
changes. Variable expenses are not constant and do change with the level of output. Because of
this, variable expenses are often stated on a per unit basis.
Once the break-even point is met, assuming no change in selling price, fixed and variable
cost, a profit in the amount of the difference in the selling price and the variable costs will be
recognized. One important aspect of break-even analysis is that it is normally not this simple. In
many instances, the selling price, fixed costs or variable costs will not remain constant resulting in a
change in the break-even.. And these changes will change the break-even. So, a break-even cannot
be calculated only once. It should be calculated on a regular basis to reflect changes in costs and
prices and in order to maintain profitability or make adjustments in the product line.
Formula for Break Even Analysis
The formula to find break even analysis is as follows:

Formula for Break Even Sales

Where:
 Fixed Cost are costs that do not change with varying output (e.g., salary, rent, building
machinery).
 Sales price per unit is the selling price (unit selling price) per unit.
 Variable cost per unit is the variable costs incurred to create a unit.
Contribution:
The contribution margin is the difference between the Total Sales and the total variable
costs. It can be calculated by the following formula:
Contribution = Actual Sales – Total Variable Cost
Contribution margin per unit
It is also helpful to note that sales price per unit minus variable cost per unit is
the contribution margin per unit.
Contribution per unit = Sales price per unit –Variable Cost per unit
Margin of Safety
Margin of safety is the difference between actual sales and breakeven point. That is, any
revenue that takes your business above break-even point can be considered as the margin of safety,
this is once you have considered all the fixed and variable costs that the company must pay.
It can be calculated by using the following formula:
Method - 1
Margin of Safety = Sales – Break Even Sales
Method - 2
Example: Delta Enterprises has the following details:

 Fixed cost = Rs. 20,00,000

 Variable cost per unit = Rs. 100
 Selling price per unit = Rs. 200
 Actual production quantity = 60,000 units

Find

a) Break Even Quantity

b) Break Even Sales
c) Contribution and Margin of Safety by both the methods.

Break Even Quantity = Rs.20,000,00 / Rs.200 – Rs.100

= 20,00,000/ Rs.100
= 20,000 units.

Break Even Sales = (Rs.20,000,00 / Rs.200 – Rs.100) X Rs.200

= (Rs.20,00,000/ Rs.100) X Rs.200
= 20,000 units X Rs.200
= Rs.40,00,000.

Contribution = Total Sales – Total Variable Cost

= (60,000 X Rs.200) - (60,000 X Rs.100)
= Rs. 1,20,000,00 – Rs.60,000,00
= Rs. 60,000,00.

Contribution per unit = Sales price per unit –Variable Cost per unit
= Rs. 200 – Rs. 100
= Rs. 100.
Margin of Safety = Actual Sales – Break Even Sales
= Rs. 1,20,000,00 - Rs.40,00,000
= Rs. 80,000,00.
Method - II

Formula to calculate profit is

Profit = Total Revenue – Total Cost

Total Revenue = Total Sales x Selling price per unit = 60,000 units x Rs.200 = 1,20,000,00

Total Cost = Total Fixed cost + Total Variable Cost = Rs. 20,000,00 + (Rs. 100 X 60,000 units) = Rs. 80,000,00

Profit = Rs. 1,20,000,00 – Rs. 80,000,00

= Rs. 40,000,00.
Margin of Safety = Rs. (40,000,00 / Rs. 60,000,00) X 1,20,000,00
= Rs. 80,000,00.