Break even

Break-even is a term used in economics, business, and cost accounting to describe the point at which total cost and total revenue are equal. It is the point at which a business neither makes a profit nor incurs a loss.

Overview

The concept of break-even is a fundamental aspect of financial management in business. It is used to determine the minimum output or sales that a company must achieve in order to cover its costs. Beyond the break-even point, every additional unit sold or produced will contribute to profit.

Calculation

The break-even point can be calculated using the formula:

Break-even point (in units) = Fixed Costs ÷ (Selling Price per unit - Variable Cost per unit)

Where:

• Fixed costs are costs that do not change with the level of output. They include costs such as rent, salaries, and insurance.
• Variable costs are costs that change with the level of output. They include costs such as raw materials and direct labor.
• Selling price is the price at which the product or service is sold to customers.

Applications

The break-even analysis is used in various areas of business including:

• Pricing strategies: To determine the minimum price at which a product must be sold to cover costs.
• Investment decisions: To evaluate the feasibility of a project or investment.
• Financial forecasting: To predict future profitability and financial performance.

Limitations

While the break-even analysis is a useful tool, it has several limitations. It assumes that all units are sold, that there is a linear relationship between costs and output, and that costs and revenues are constant over time. These assumptions may not hold true in real-world situations.

See also

• Cost-volume-profit analysis
• Margin of safety (finance)
• Operating leverage