Managers use decision-making information such as performance, financial, and managerial reports to ascertain specific or overall business health. The information gathered serves the purpose of enhancing the use of limited resources by assigning them to those with major possibilities. In this blog, we introduce the use of break-even analysis using two formulas: break-even in units and break-even in revenues. (For this example, we use dollars, but feel free to switch to your home currency.) Thus, the break-even formulas will be used for analysis and decision-making.
What is the purpose of break-even analysis?
The break-even analysis provides managers and business people the ability to identify how much in units or revenues must be achieved to cover all expenses. As you know, we plan our business for profit. We want to excel in our industry by serving our customers well, taking care of our employees, and reinvesting in our business. Knowing your break-even helps managers in planning how resources get assigned.
Necessary Assumptions
- Units sold are the only cost and revenue drivers.
- Total costs has two components: variable and fixed costs.
- Variable and fixed costs and revenues are constant and known within the relevant range.
Break-even Analysis in Units
Break-even means that no gain or loss arises from operations. The following formula calculates the quantity of units sold to achieve a break-even.
[(SPu x Q sold) – (VCu x Q sold)] – FC = Operating Income
where
- SPu – Selling Price per unit
- Q sold – Quantities sold
- VCu – Variable Cost per unit
- FC – Total Fixed Cost, not per Unit
Contribution Margin (CM) = (Sales – Variable Cost) or (SPu – VCu) x Q sold
Contribution Margin per Unit (CM per Unit) = SPu – VCu
Contribution Margin Percentage or Ratio (CM %) = CM / Revenues
To obtain break-even in Units = Total Fixed Cost / CM per Unit or break-even in Units = Total Fixed Cost / (SPu – VCu)
To obtain break-even in Revenues = Total Fixed Cost / CM %
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