Break- Even Analysis

ROSSBETH B.
LIANGCO
Concepts of Production Management and Operations
Management

Learning Objectives

1. Define break-even analysis.

2. Understand the used and limitations of break-even

analysis

3. Compute break-even and contribution margin.

What is BREAK -EVEN ANALYSIS?

A break-even analysis is a financial tool which helps a company to determine the

stage at which the company, or a new service or a product, will be profitable. In
other words, it is a financial calculation for determining the number of products or
services a company should sell or provide to cover its costs (particularly fixed
costs).

Break-even point (BEP)- is the point at which total cost and total revenue are
equal.
- There is no net loss or gain
BREAK -EVEN ANALYSIS

Break-even is a situation where an organisation is neither making

money nor losing money, but all the costs have been covered.
Break-even analysis is useful in studying the relation between the
variable cost, fixed cost and revenue.
Generally, a company with low fixed costs will have a low break-even
point of sale
BREAK -EVEN ANALYSIS

CM>FM
Profit
Making
Total Amount 50k units Contribution
Margin
$4 per unit
$

$200,000 Fixed Cost

Mak FC
Los ing
<
CM

Number of Units Sold

Components of Break- Even Analysis

a) Fixed Cost
b) Variable Cost
c) Contribution Margin
d) Contribution Margin Ratio
Components of Break- Even Analysis

A) FIXED COST
Fixed costs are those business costs that are not directly related to the level of
production or output. In other words, even if the business has a zero output or high
output, the level of fixed costs will remain broadly the same.

Examples of fixed costs:

- Rent and rates
- Research and development
- Marketing costs (non- revenue related)
- Administration costs
Components of Break- Even Analysis

B) VARIABLE COST

Variable costs are those costs which vary directly with the level of output. They represent payment
output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as
commission.

A distinction is often made between "Direct" variable costs and "Indirect" variable costs.

a) Direct variable costs are those which can be directly attributable to the production of a
particular product or service and allocated to a particular cost centre. Raw materials and
the wages those working on the production line are good examples.
b) Indirect variable costs cannot be directly attributable to production but they do vary with
output. These include depreciation (where it is calculated related to output - e.g. machine
hours), maintenance and certain labour costs.
Components of Break- Even Analysis

C) CONTRIBUTION MARGIN
❖ Contribution margin is a product’s price minus all associated variable costs, resulting in
the incremental profit earned for each unit sold

Sales - Variable Cost

❖ The total contribution margin generated by an entity represents the total earnings
available to pay for fixed expenses and to generate a profit.

“Money used to pay off Fixed

Cost”
 Sales - Variable Cost = Contribution Margin

Example (Total) Example (per Unit)

Sales- Php 50,000 Price per Unit- Php

5,000
VC- Php 30,000 VC per Unit- Php 3,000

50,000 - 30,000 = 20,000 5,000 - 3,000 = 2,000 per Unit

EXAMPLES for Contribution Margin

Components of Break- Even Analysis

D) CONTRIBUTION MARGIN RATIO

The contribution margin ratio is the difference between a company's sales and
variable expenses, expressed as a percentage. The total margin generated by an
entity represents the total earnings available to pay for fixed expenses and
generate a profit

CONTRIBUTION MARGIN RATIO= CONTRIBUTION MARGIN / SALES

REVENUE
 Contribution Margin Ratio = Contribution Margin / Sales
Revenue

Example (Total) Example (per Unit)

Sales- Php 50,000 Price per Unit- Php

5,000
VC- Php 30,000 VC per Unit- Php 3,000

5,000 - 3,000 = 2,000 per Unit

50,000 - 30,000 = 20,000

Contribution Margin Ratio = 20,000/ Contribution Margin Ratio per unit= 2,000/ 5,000
50,000
= .40 or 40%
= .40 or 40%

EXAMPLES for Contribution Margin Ratio

 Calculation of Break-even Analysis

The break-even point formula is calculated by dividing the total fixed costs of production by the price
per unit less the variable costs to produce the product.

Since the price per unit minus the variable costs of product is the definition of the
contribution margin per unit, simply rephrase the equation by dividing the fixed costs by the contribution
margin
Next, the break-even formula in sales dollars is calculated by multiplying the price of
each unit by the answer from the first equation.

This will provide the total dollar amount in sales needed to achieve in order to have zero
loss and zero profit

Break Even Point in Dollars

 Now, compute the total number of units that need to be sold in order to achieve a certain level
profitability without break-even calculator.

First, take the desired dollar amount of profit and divide it by the contribution margin per
unit. The computes the number of units needed to sell in order to produce the profit without taking
in consideration the fixed costs. Then add back in the break-even point number of units.

Number of Units to Produce the Desired Profit

 EXAMPLE

Barbara is the managerial accountant in charge of a large furniture factory’s production lines
and supply chains. She isn’t sure the current year’s couch models are going to turn a profit and
what to measure the number of units they will have to produce and sell in order to cover their
expenses and make at $500,000 in profit. Here are the production stats. Compute for the (a)
break-even point in unit, (b) break-even point in dollar sales, and (c) number of units to
produce the desired profit given the following data.

● Total fixed costs : $500,000

● Variable costs per unit : $300
● Sale price per unit : $500
● Desired profits : $200,000
 ● Total fixed costs : $500,000
● Variable costs per unit : $300
● Sale price per unit : $500
● Desired profits : $200,000

Step 1: First, calculate the break-even point per unit, so we will divide the $500,000 of fixed
costs by the $200 contribution margin per unit ($500 – $300)

The Barbara’s factory will have to sell at least 2,500 units in order to cover its fixed and variable costs.
Anything it sells after the 2,500 mark will go straight to the CM since the fixed costs are already covered.
 ● Break Even Points in Units : 2500
● Sale price per unit : $500
● Desired profits : $200,000

Step 2: Next, Barbara can translate the number of units into total sales dollars by multiplying the 2,500 units by
the total sales price for each unit of $500.

Now Barbara can go back to the board and say that the company must sell at least 2,500 units or
the equivalent of $1,250,000 in sales before any profits are realized
 ● Total fixed costs : $500,000
● Variable costs per unit : $300
● Sale price per unit : $500
Step 3: She can also take it a step further and use a break- ● Desired profits : $200,000
even point calculator to compute the total number of units ● Break Even # of units : 2,500
that must be produced in order to meet her $200,000
profitability goal by dividing the $200,000 desired profit
by the contribution margin then adding the total number of
break-even point units