Break-Even Analysis

Definitions used in Break-Even Analysis: Break Even: Number of units that must be sold in order to produce a profit of zero (but will recover all associated costs). i.e. At what volume of sales will you start to make money? Break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for your company Break Even = Fixed Cost / (Unit Price - Variable Unit Cost)

The Break-even Analysis depends on three key assumptions: Average per-unit sales price (per-unit revenue): This is the price that you receive per unit of sales. Take into account sales discounts and special offers. The vast majority of businesses sell more than one item, and have to average because break-even analysis requires a single number

2. Average variable per-unit cost: This is the incremental cost, or variable cost, of each unit of sales. If you buy goods for resale, this is what you paid, on average, for the goods you sell. If you sell a service, this is what it costs you, per dollar of revenue or unit of service delivered, to deliver that service. 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.

3. Monthly fixed costs: Fixed costs are overhead-type expenses that are constant and do not change as the level of output changes. Technically, a break-even analysis defines fixed costs as costs that would continue even if you went broke. However, it is recommended that you use your regular running fixed costs, including payroll and normal expenses (total monthly Operating Expenses).

Break-even should not be calculated only once Break-even should not 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.

Example

Suppose the fixed expenses look as follows: Administrative salaries $1,500 Rent 800 Utilities 300 Insurance 150 Taxes 210 Telephone 240 Auto expense 400 Supplies 100 Sales and marketing Interest Miscellaneous Total $4,500

Gross Margin = P – V.C = 0.25 Break Even = 4500/0.25 Fixed Cost = 4500 Gross Margin = P – V.C = 0.25 Break Even = 4500/0.25

using the income statement Let us use Excel's Goal Seek to back solve for the break-even point using the income statement

call up Excel's Goal Seek from Excel’s main menu by clicking on Tools and then Goal Seek Set-up the Goal Seek dialog box by entering Accounting Profit in cell B17 as the Set Target Cell. In the Equal to row, click on the option button for Value of and enter 0 in the adjacent box. Enter Unit Sales in cell B12 as the By Changing Cell. See the figure below

Let us use sensitivity analysis to draw the graphical representation of Break- Even point

Create A List of Input Values and An Output Formula using Edit/ Fill/ Series/ Row and Create a list of input values for Break -Even (0, 5,000, 10,000, etc.) in the range C21:G21. Create output formulas that reference the pieces of the accounting profit calculation. Specifically: for Fixed Cost, enter  =B16  in cell B22 for Variable Costs, enter   =B14  in cell B23 for Total Costs, enter  =B16+B14  in cell B24 for Sales Revenue, enter  =B13  in cell B25   for Accounting Profit, enter  =B17  in cell B26

Select the range B21:G26 for the Data Table Then choose Data  Table from the main menu and a Table dialog box pops up. Enter the cell address B12 (Unit Sales) in the Row Input Cell and click on OK. Highlight the data table C21:G26 and then choose  Insert  Chart from the main menu. Select an  XY(Scatter)  chart type

The graph shows visually that the Break-Even Point is 15,000 units. The graph illustrates two equivalent intuitions for this result. First, the Break-Even Point is where the Sales Revenue line (in green) crosses total Costs line (in Black). 2. Second, the Break-Even Point is where Accounting Profit (in blue) hits zero and thus decisively switches from negative to positive. EBIT = 0