Resources | Subject Notes | Business Studies
Break-even analysis is a crucial tool for businesses to understand the relationship between costs, revenue, and profit. It helps determine the point at which total revenue equals total costs – the point where the business is neither making a profit nor a loss. This point is known as the break-even point.
Fixed costs are expenses that do not change with the level of production or sales. Examples include rent, salaries, insurance, and depreciation.
Variable costs are expenses that change directly with the level of production or sales. Examples include raw materials, direct labor, and sales commissions.
The break-even point can be calculated in terms of either units or revenue.
The break-even point in units tells you how many units a business needs to sell to cover all its costs.
The formula for calculating the break-even point in units is:
$$ \text{Break-Even Point (Units)} = \frac{\text{Fixed Costs}}{\text{Selling Price per Unit} - \text{Variable Cost per Unit}} $$
The break-even point in revenue tells you the total revenue a business needs to generate to cover all its costs.
The formula for calculating the break-even point in revenue is:
$$ \text{Break-Even Point (Revenue)} = \frac{\text{Fixed Costs}}{\left(1 - \frac{\text{Variable Cost per Unit}}{\text{Selling Price per Unit}}\right)} $$
| Variable Cost per Unit | Selling Price per Unit | Fixed Costs | Break-Even Point (Units) | Break-Even Point (Revenue) |
|---|---|---|---|---|
| $5 | $10 | $2000 |
$$ \frac{2000}{10 - 5} = \frac{2000}{5} = 400 $$
The business needs to sell 400 units to break even. |
$$ \frac{2000}{1 - \frac{5}{10}} = \frac{2000}{1 - 0.5} = \frac{2000}{0.5} = 4000 $$
The business needs to generate $4000 in revenue to break even. |
Figure: Suggested diagram: A graph showing total revenue and total costs intersecting at the break-even point.
Break-even analysis is important for several reasons: