Firstly lets look at the terms used in this post:
The Break-Even point in sales volume is defined as:
“ That point in sales volume, or revenue, where direct costs have been recovered, fixed overhead expenses have been absorbed and where profit begins”
Contribution is the SALES less VARIABLE COSTS
Contribution is so called as it literally does contribute towards fixed costs and profit, As sales revenue grow from zero, the contribution also grows until it just covers the fixed costs. This is the break-even point where neither profits or losses are made.
It follows that to break-even the contribution must exactly equal the amount of fixed costs. If we know how much the contribution is for each unit sold, then we can calculate the amount of units required to break even as follows.
Break even point in units = fixed costs / contribution per unit
For example if an organisation manufactures a single product, incurring variable costs of €50 per unit and fixed costs of €10,000 per month. Of the product sells for €100 per unit then the break even point can be calculated as follows.
= 10,000 / 50
so the break even point is 200 units
Using Break-Even in Modeling:
The Break-Even formula can be used as a model to estimate the effect of major decisions on the financial status of the business such as adding a new location, making a capital investment, dropping or adding a product line. Simply estimate the changes in fixed and variable costs (and sales) that result from the decision and plug them into the Break-Even formula for your company. This can also help you set goals for the new operation.
In fact, ANY significant contemplated change in your cost structure resulting from a proposed decision can be modeled to determine the effect on the company’s financial results before the decision is made. You will know what you face and are required to overcome ahead of time. You will be able to set goals based on financial facts rather than intuition only.
Break even point can be shown graphically at at the point where the total revenue and total cost curves meet.
Limitations of Break Even Analysis:
It is best suited to the analysis of one product at a time. It may be difficult to classify a cost as all variable or all fixed; and there may be a tendency to continue to use a break even analysis after the cost and income functions have changed.