# Break Even Analysis

Topics: Variable cost, Costs, Total cost Pages: 10 (3053 words) Published: April 12, 2013
Executive Summary
One of the most common tools used in evaluating the economic feasibility of a new enterprise or product is the Break even. The Break even point is the point at which revenue is exactly equal to costs. At this point, no profit is made and no losses are incurred. The break even point can be expressed in terms of unit sales or dollar sales. That is, the break even units indicate the level of sales that are required to cover costs. Sales above that number result in profit and sales below that number result in a loss. The break even sales indicate the dollars of gross sales required to break even. The determination of the break-even point of a firm is an important factor in assessing its profitability. It is a valuable control technique and a planning device in any business enterprise. It depicts the relation between total cost and total revenue at the level of a particular output. Ordinarily, the profit of an industrial unit depends upon the selling price of a product (revenue), volume of business (it depends on price) and cost price of the product. A company has broken even when its total sales or revenues equal its total expenses. At the breakeven point, no profit has been made, nor have any losses been incurred. This calculation is critical for any business owner, because the breakeven point is the lower limit of profit when determining margins.

Defining Costs
There are several types of costs to consider when conducting a breakeven analysis, Fixed costs: These are costs that are the same regardless of how many items sold. All start-up costs, such as rent, insurance and computers, are considered fixed costs. Variable costs: These are recurring costs that are absorbed with each unit sold For example, if a company was operating a greeting card store where it had to buy greeting cards from a stationary company for \$1 each, then that dollar represents a variable cost. As the business and sales grow, it can begin appropriating labor and other items as variable costs if it makes sense for the industry.

Algebraic Formulate of Break-Even Analysis
A. Break-even point (BEP) in terms of sales:
BEP in terms of sales volume can be calculated using the following formula: [pic]

Where
FC = fixed cost
SP = selling price per unit
VC = variable cost per unit

[pic]
Where total contribution is the total sales minus the total variable expenses. In this case the BEP will be in dollars

Graphically,
BEP is represented as below.
[pic]

Break even analysis is used in the following sense in the company: ➢ It serves as the most useful and important managerial tool to study Cost--Output-Profit relationship at varying level of output. ➢ It is useful in reviewing pricing policies

➢ It aids in planning capitalization of the enterprise. ➢ It provides the entrepreneur to decide whether to acquire or not assets involving additional fixed costs. Setting a Price
This is critical to your breakeven analysis; you can’t calculate likely revenues if you don’t know what the unit price will be. Unit price refers to the amount planned to charge customers to buy a single unit of the product. Psychology of Pricing: Pricing can involve a complicated decision-making process on the part of the consumer, and there is plenty of research on the marketing and psychology of how consumers perceive price. Pricing Methods: There are several different schools of thought on how to treat price when conducting a breakeven analysis. It is a mix of quantitative and qualitative factors. If you’ve created a brand new, unique product, you should be able to charge a premium price, but if you’re entering a competitive industry, you’ll have to keep the price in line with the going rate or perhaps even offer a discount to get customers to switch to the company.

One common strategy is "cost-based pricing", which calls for figuring out how much it will cost to produce one unit of an item and setting the price...

Please join StudyMode to read the full document