Breakeven point
The breakeven point is a result found with breakeven analysis. In the most frequently used forms of this analysis, the breakeven point answers questions like this: "How many units must we sell before we begin earning a profit? How many tenants must a rental apartment building have in order for the owner to cover the costs of owning and maintaining the building?
Breakeven analysis is a central concept in business planning, especially when planning involves decisions about new product launch, start up of a new business, or when acquiring expensive assets (the Fixed Costs in the equations below). Planners will carefully consider, among other things, the likelihood of selling the breakeven quantity or more.
Business analysts also refer to a similar but different concept, the breakeven point in time, that is the period of time required for investment returns to cover investment costs. See the Encyclopedia entry for payback period for complete coverage of this concept.
• Simple Breakeven
• Graphical Solution for Simple Breakeven
• Breakeven with Semivariable Costs and Prices
Simple Breakeven
The simplest form of breakeven analysis considers just three input variables (however, see the section on breakeven with semivariable costs and prices, below). The three inputs to the simple breakeven formula are::
- Net cash inflow per unit (e.g., selling price per unit sold)
- Fixed costs: Costs that are constant no matter what the unit volume (usually including such things as equipment and facilities costs, and salaries of research or executive staff).
- Variable costs that vary by the unit, such as factory direct labor costs, materials costs, and sales commissions.
The simple breakeven formula at left shows how these inputs produce the breakeven quantity, "Q."
Suppose for instance, a manufactured item is produced and sold with these values:
F = Total Fixed costs = $120,340
v = Variable cost per unit = $26.87
P = Selling price per unit = $75.00
The breakeven number of units (breakeven point) is:
Q = (120,340) / (75.00 – 26.87) = 120,340 / 48.13 = 2,500.3 units
Since it's not possible to sell a fractional unit, this breakeven quantity Q will be rounded up to 2,501 units. With Q now known, the result can be verified by calculating:
Total inflows = Q P = (2,500.3 ) ( $75.00) = $187,523
and
Total costs = Fixed costs + Variable Costs = F + (Q v)
= 120,340 + (2,500.3)($26.87) = $187,523
[ Page Top ] [ Encyclopedia ] [ Business Case Books & Tools ] [ Home ]
Graphical Solution for Simple Breakeven
The interrelationships between input variables and total costs in the breakeven calculation may be appreciated from a graphical analysis. 
All four of the "curves" on the graph show resulting values (vertical axis) as a function of units sold (horizontal axis). Because the simple breakeven equation is a linear equation, all :"curves" appear as straight lines on the graph. The lowest curve on the graph, "Net Cash Flow" is the difference between net inflows and net outflows. As unit volume increases, net cash flow climbs from negative to positive values. The breakeven quantity is the unit volume were net cash flow cross 0 on the vertical axis.
For working spreadsheet examples of the breakeven equation and breakeven graphs, as shown above, see Financial Metrics Pro.
[ Page Top ] [ Encyclopedia ] [ Business Case Books & Tools ] [ Home ]
Breakeven Analysis with Semivariable Costs and Prices
In reality, inflow per unit, fixed costs, and variable costs per unit may all change with volume.
- Above a certain unit volume, for instance, a company may have to add more production staff or production equipment. These costs become semivariable fixed costs.
- The variable costs per unit may also change above or below certain volumes. With volume production runs, for instance, direct labor costs per unit may be less than with smaller production runs. This creates different variable costs for different volumes.
- In order to achieve high unit volume, the company may have to lower selling price to reach higher volumes, or offer volume discounts, or tiered pricing based on quantity orderd. The result is that not all units are sold at the same price. This creates semivariable inflows.
Under any or all of the above conditions, the simple breakeven equation is not accurate. The actual unit volume that exactly balances total cash outflows with total cash inflows (the breakeven point) has to be calculated recognizing each of the above relationships between volume, cost, and price.
For further discussion of semivariable input to the breakeven analysis, and a working spreadsheet example, see Financial Metrics Pro.
[ Page Top ] [ Encyclopedia ] [ Business Case Books & Tools ] [ Home ]
© Copyright Solution Matrix Ltd. 2004 - 2010
