Break Even Analysis

A breakeven analysis is used to determine how much sales volume your business needs to start making a profit.The breakeven analysis is especially useful when you're developing a pricing strategy, either as part of a marketing plan or a business plan.

To conduct a breakeven analysis, use this formula:
Fixed Costs divided by (Revenue per unit - Variable costs per unit)
Fixed costs are costs that must be paid whether or not any units are produced. These costs are "fixed" over a specified period of time or range of production.

Variable costs are costs that vary directly with the number of products produced. For instance, the cost of the materials needed and the labour used to produce units isn't always the same.
    

    

For example, suppose that your fixed costs for producing 100,000 widgets were Rs.30,000 a year.
Your variable costs are Rs.2.20 materials, Rs.4.00 labour, and Rs.0.80 overhead, for a total of Rs.7.00.
If you choose a selling price of $12.00 for each widget, then:
Rs.30,000 divided by (Rs.12.00 - 7.00) equals 6000 units.
This is the number of widgets that have to be sold at a selling price of Rs.12.00 before your business will start to make a profit.

Limitations

• Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.
• It assumes that fixed costs (FC) are constant. Although, this is true in the short run, an increase in the scale of production is likely to cause fixed costs to rise.
• It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. linearity)