The term "break-even analysis" refers to the point at which a company's total cost and total revenue are equal. The number of units or dollars of revenue required to cover all costs is determined using a break-even point analysis (fixed and variable costs).
The formula for Break-Even Analysis
The formula for break-even analysis is as follows: (In terms of quantity)
Break-even quantity = Fixed costs / (Sales price per unit – Variable cost per unit)
Where:
Fixed costs 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.
It is also helpful to note that sales price per unit minus variable cost per unit is the contribution margin per unit. For example, if a book’s selling price is INR 100 and its variable costs are INR 20 to make the book, INR 80 is the contribution margin per unit and contributes to offset the fixed costs.
The formula for break-even analysis is as follows: (In terms of Sales)
Break-even sales = Fixed costs /[ (Sales – Variable costs)/Sales]
Where:
Fixed costs are costs that do not change with varying output (e.g., salary, rent, building machinery).
Sales here is the total sales value
Variable cost is the total variable cost incurred
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. When used on an individual unit sale, the ratio expresses the proportion of profit generated on that specific sale.
The break-even point is the point at which total fixed and variable costs equal total revenues. A business does not make a profit or a loss at the break-even point. As a result, the break-even point is often known as the "no-profit" or "no-loss" threshold.
The break-even analysis is important in determining how many units (or revenues) are needed to cover fixed and variable expenses of the business.
Therefore, the concept of break-even point is as follows:
Profit when Revenue > Total Variable cost + Total Fixed cost
Break-even point when Revenue = Total Variable cost + Total Fixed cost
Loss when Revenue < Total Variable cost + Total Fixed cost
But, there are "Limitations"
Break-even analysis plays an important role in making business decisions, but it’s limited in the type of information it can provide.
Not So Dynamic
The formula for calculating the break-even point is straightforward. Many firms sell a variety of products at different rates. That nuance won't be picked up by it. You'll probably have to work with one product at a time or make an average pricing estimate based on all the things you'll be selling. If this is the case, it's a good idea to practise a few different scenarios in order to be more prepared. As prices fluctuate, so do costs. This model assumes that only one thing changes at a time. Instead, if you lower your price and sell more, your variable costs might decrease because you have more buying power or are able to work more efficiently. Ultimately it’s only an estimate.
Not the Right "Time"
The break-even analysis overlooks time variations. The time frame you choose to compute fixed expenses will determine the time frame you use (monthly is most common). Although you'll be able to see how many units you need to sell over the course of a month, you won't be able to see how things alter if your sales move week to week or seasonally over the course of a year. It also neglects to consider the future. Break-even analysis just considers the present.
No Demand Predictions
It's vital to remember that a break-even analysis isn't a demand prediction. It won't tell you how much money you'll make or how many people will want to buy what you're selling. All it will tell you is how many units you need to sell to break even. It's also worth noting that demand isn't consistent over time and you have to keep a note of these variations and balance it out if required.