Question

A break-even analysis can be used to determine the amount of sales volume a business needs to start making a profit. List the formula used to conduct a break-even analysis and explain each component. Provide a real-world example of how the break-even analysis and formula could be applied.

Answer 1

A break even point can be defined as the point at which the total cost incurred is equal to the total revenues generated. At this point there is neither profit nor loss to the business.

The formula for calculating the break even units is:

= Fixed costs / (Sales price per unit – Variable cost per unit)

· Fixed costs are all the costs associated with producing the product or service. They are fixed and do not depend on the production numbers. Rent, machinery cost etc are examples of fixed cost

· Sales price per unit is the selling price charged by the business for each product.

· Variable costs are costs related to the production of the product. They are not fixed and vary as per the production numbers. Examples are cost of raw materials, utilities costs, transportation, etc.

Let us assume it takes $1000 in fixed costs to set up a hot dog stand. The selling cost per hot dog is $5 and variable cost is $2. The break even point can be calculated as

= 1000/(5-2)= 333.3 = ~334.

Thus the business will have to sell a minimum of 334 hot dogs to break even. At this point there is neither profit nor loss. He will get a profit when the sales number exceed 334 and there will be loss if sales are less than 334.