BreakEven Analysis  Explained
What is a BreakEven Analysis?
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What is a BreakEven Analysis?
Breakeven analysis is an economic assessment of the mathematical correlation between sales and expenses revenue, under a specified set of assumptions concerning variable and fixed costs. Plainly stated, it is a measure of how long it will take for a project or investment to pay for itself.
How is a BreakEven Analysis Used?
A breakeven analysis can be beneficial when determining the level of production or in a targeted desired sales mix. The analysis produces a metric and calculations not necessary to share with investors, financial institutions, or other third parties, so it used for managerial purposes only.
Breakeven analysis looks at the position of fixed costs as they relate to profit earned by each extra item sold or produced. For example, the breakeven point of sale will be lower for a company with lower fixed costs. If fixed costs are $0, a company automatically breaks even with the purchase of the first product provided the variable costs are not more than the sales revenue. Since variable costs are expenses incurred for each sold item, accumulating them will limit a company's leverage.
The idea of breakeven analysis has to do with a products contribution margin, which is the excess between the sold price of a product and the total variable costs. Take for example a product that sells for $120. The total fixed costs are $30 per product. The total variable costs are $70 for each item. Therefore, the contribution margin is $50 because the total variable costs get subtracted from the selling price. When determining the contribution margin, the fixed costs are not considered.
Two formulas can be used to calculate the breakeven analysis. The first is to divide the total fixed costs by the contribution margin. Assume a company's fixed costs are $20,000 and you divide by a contribution margin of $40, the breakeven point obtained is 500 units. Therefore, all fixed costs will be paid for after the sale of 500 products. The company can then record a net profit or loss of $0. The second formula to calculate the breakeven point in terms of sales dollars is to divide the total fixed costs by the ratio of the contribution margin. To get the ratio, divide the contribution margin by the sale price. So, with the above example, assume the sale price for each product is $100. When the $40 contribution margin gets divided by the sale price of $100, the contribution ratio comes out to be 40 percent.
Remember the fixed costs were $20,000. So that total divided by the 40 percent makes the sales dollars breakeven point $50,000. To check, take the breakeven point in units, which was 500, and multiply it by the sales price of $100 and it equals $50,000.
Related Topics
 Trend Analysis of Financial Statements
 CommonSize Analysis (Vertical Analysis) of Financial Statements
 CommonSize Financial Statement
 Net Dollar Retention
 Horizontal Analysis
 Per Share Basis
 Profitability Ratios
 Gross Margin Ratio
 Profit Margin
 After Tax Profit Margin
 Return on Assets
 Total Shareholder Return
 Cash on Cash Return
 Earnings Per Share
 Diluted Earnings Per Share
 Asset Turnover Ratio
 Berry Ratio
 BreakEven Analysis
 Liquidity Ratio
 Current ratio (Working Capital Ratio)
 Working Ratio
 Quick Ratio
 Quick Assets
 Days Sales Outstanding
 Cash Ratio (Operating Cash Flow Ratio)
 Receivables turnover ratio (often converted to average collection period)
 Accounts Payable Turnover Ratio
 Inventory turnover ratio (often converted to average sale period)
 Solvency (Coverage Ratios)
 Leverage Ratio (Debt Ratio)
 Asset Coverage Ratio
 Debt to Equity
 Debt to Income Ratio
 Debt Coverage Ratio
 Times Interest Earned
 Market Capitalization
 Price to Equity Ratio
 BookToMarket Ratio
 Price to Earnings Ratio
 Price to Earnings Growth (PEG) Ratio
 Price to Earnings Growth Payback Ratio
 CAPE Ratio
 Price to Cash Flow Ratio
 Capital Maintenance
 Book to Bill Ratio
 Asset Turnover Ratio
 Plowback Ratio
 Days Inventory Outstanding
 Days Payable Outstanding
 Days Sales Outstanding
 Nonfinancial Performance Measures: The Balance Scorecard