Break-Even Analysis

Break even analysis is an essential economic tool which helps to determine the point beyond which a company earns profit. It helps businesses calculate the volume of products which needs to be sold so that a company overcome all the initial cost of investment. Reaching this break-even point means that a company is no more in a state of loss.


What is the Break-Even Point? 

In a business scenario, the break-even point is a perimeter at which the total expenses of the enterprise equals the total revenue generated. Reaching this point indicates that a business has overcome all the expenses and no more in a state of loss. 

Since this calculation reveals such vital information of a business, it is a necessity to learn and calculate break-even point accurately. 

To understand this further, consider this formula. 

Break-even point = Fixed Cost / (Price per cost - Variable cost) = Fixed Cost / Gross Profit Margin

Where, 

  • Fixed cost refers to the cost incurred in a business unit, which doesn’t depend upon the volume of production. For example, rent, loans, insurance premiums, etc. comes under fixed cost. 

  • Variable cost is the cost to produce one unit of product. 

Example 

Let us understand this equation by taking a break even analysis example mentioned as follows. 

A factory ABC Enterprises produces a particular kind of good wherein the total fixed costs stands at Rs.50,000 and variable cost to produce a good is Rs.30. The company sold these goods with a sale price per unit of Rs.50. 

In this case, 

Break-even point = 50,000/ (50-30) = 2500 units 

So, from the above break even analysis, it is evident that BEP (break-even point) for ABC enterprises stands at 2500. This means a company will have to sell at least 2500 units of the product to overcome this fixed and variable costs incurred for production. 

This can further help companies in determining the total sales achieved by the company then. They need to multiply the break-even point with the sale price per unit to do so. In this case, the value of total sales made by the company at their break-even point will be equal to (2500*50) Rs.1,25,000. 

Numerical to Solve 

  1. A company produces goods at a variable cost of Rs.12 per unit, and the same is sold at Rs.20 per unit. Fixed cost incurred by a company for a period stands at Rs.40,000. Calculate the number of products a company needs to manufacture to attain a profit target of Rs.10,000. 

  2. Check the following table to know about cost analysis for 6 months of a business operation. 

Material costs 

Rs.150 per set 

Price 

Rs.850 per set 

Sets 

1800

Other variable costs 

Rs.150 per unit 

Labour costs 

Rs.150 per set 

Overheads 

Rs.6,00,000 (for 6 months)


  1. Calculate the breakeven quantity 

  2. Draw break-even chart for the 6 months of business operation 

  3. Determine the profit earned by an organisation 

  1. Fixed costs of an enterprise is Rs.3,00,000, and the variable cost and selling price of the product is Rs.42 per unit and Rs.72 per unit, respectively. The company expects to sell 15,000 units of the product whereas it has a maximum factory capacity of 20,000 units. Draw a break-even chart depicting the break-even point and determine the profit earned at this current situation. 

Students can solve these numerical quickly and accurately after they have a thorough understanding of the concept of break even analysis. To understand why do we need to calculate this, look at its importance in detail.

Significance of Break Even Analysis 

  • Determined Volume of Products to be Sold 

As per the break even analysis definition, its calculation can help companies determine the minimum number of goods to be sold so that the total fixed and variable cost of production is met. Therefore, a company already has an exact figure about the number of units to be sold to overcome losses. 

  • Deciding Budgets and Targets 

Since break-even analysis gives businesses an idea about the operational scenario, it helps plan the budget for various business operations becomes easy. Besides, they can set objectives to accelerate the production speed and achieve them positively. 

  • Cost Control 

Fixed and variable costs may have an impact on an organisation's profit margin. But, with break-even analysis of the business operations, they will be able to evaluate if any effects are changing the value of cost. In such scenarios, controlling cost becomes a necessity to ensure they earn profit from business operations. 

  • Designing of Price Strategy 

Pricing of products has a huge impact on the calculation of break-even point. For instance, if the price of goods increases, then understandably their break-even point will be reduced. For example, if earlier an organisation needed to sell 50 units of this product to reach breakeven, it will be attained at only 45 units if the selling price is increased. 

  • Margin of Safety Management 

Sales of goods can significantly decline at a situation of financial crisis or breakdown. In such scenarios, managing margin of safety becomes easier with concepts like break even analysis. That’s because the company will have an idea on the minimum number of products they need to sell to ensure their organisation doesn’t undergo any loss.

The margin of safety can be calculated by the following formula, 

Margin of safety = (current sales level – Break-even point)/ Current sales level 

Or, Margin of safety = (current sales level – Break-even point)/ Selling price per unit  

These are a few pointers which briefly discuss why it is important to calculate break-even point and study it in a business environment. 

Components of Break-even Analysis 

The two components which help define break even analysis are mentioned as follows 

  1. Fixed Cost 

Costs incurred in running a business which doesn’t vary with volume of the production are known as a fixed cost. Also known as an overhead cost, examples of fixed cost are salaries, rent, premiums, loans, bills, etc. 

  1. Variable Cost 

This is the cost which varies as the number of manufactured products fluctuates. Cost of fuel, raw material, packaging, etc. comes under this.

Applications of Break-Even Analysis 

  • Planning in New Businesses

New businesses have a lot to plan before they introduce a facility and start manufacturing goods for sale. To ensure the plans regarding cost and pricing of goods are done right, break even analysis is a necessity. One will be able to analyse and state if the new business idea is productive or not. 

  • Introduction of New Products 

For cases, a company wishes to introduce the production of new products in its business unit; the study of break-evens can emerge very significant. Before they start producing the goods, analysing break-even will help them understand the cost and pricing strategy. 

  • Business Model Modification 

Change in a business model may have an impact on your businesses productivity. The change of model doesn’t necessarily mean it will affect the costs and expenses, but if that’s the case, it will help you change your selling price accordingly. Hence, analysing break-even in this scenario is both feasible and important. 

Further, while discussing, the term marginal costing and break even analysis may appear frequently. Marginal cost is the extra cost incurred in producing one extra unit of a good. This can help determine how variable costs can affect the volume of production in a business unit. 

Understanding break even analysis meaning will help students get an in-depth idea about this economic concept. Students looking for comprehensive study material can browse to Vedantu’s official website or download the app to access the study notes. All our study materials are prepared by experienced and qualified teachers and are guaranteed to help students learn the nuances of the subject intricately. 

Multiple Choice Questions 

  1. For 10,000 units of sales, the variable cost per unit is Rs.12, Selling price per unit is Rs.20, and fixed cost is Rs.50,000. Calculate the profit earned and choose an accurate answer. 

  1. Rs.5,000

  2. Rs.30,000

  3. Rs.20,000

  4. None of the above 

Ans: b

  1. A company’s fixed cost is estimated at Rs.50,000, variable cost percentage is 66 2/3% and capacity is Rs.3,00,000. Calculate its BEP capacity. 

  1. 30% 

  2. 50%

  3. 25%

  4. None of the above 

Ans: b

FAQ (Frequently Asked Questions)

1. What is Break Even Analysis?

Ans. Break even analysis is an essential economic tool which helps businesses determine the minimum number of products they need to sell in order to recover the costs. It helps businesses plan for various attributes.

2. Explain Break Even Analysis.

Ans. It is an economic tool which helps calculate the point beyond which a company isn’t any more in a loss. They reach a point in business operations wherein the total costs equal the total revenue generated.

3. Write Down the Break Even Sales Formula.

Ans. The break-even sales can be calculated by multiplying the selling price per unit with the break-even point, i.e., the number of units to be produced. This break-even point can be calculated by the formula (Fixed cost / price per cost – variable cost).