A break even analysis is a method, which denotes what is the ideal quantity of production and the minimal amount of sales to guarantee that there is no monetary loss of a project. Break even analysis forms an integral part of capital budgeting.
The least possible quantity at which there is no loss of money is termed as break even point. In other words, the break even point for an item is the level where the whole amount of revenue is equivalent to the whole amount of costs related to the selling of the item. If total revenue is considered as TR and total costs are considered as TC, the break even point can be expressed as TR = TC.
Usually, a break even point is computed for commercial enterprises for ascertaining whether it is profitable if a suggested item is sold and the idea is in opposition to an effort to alter a present item rather such that it may become attractive.
Break even analysis may also be utilized for the assessment of the probable profitableness of a cost in a business based on sales. In case an item is sold at a higher volume in comparison to the break even point, the company selling the product would be able to attain a profit. If the item is sold under the break even level, the company will incur a loss.
The break even quantity is computed with the help of the following formula:
Break even quantity = Total Fixed Costs/Selling Price – Average Variable Costs
Description – in the denominator part, selling price minus average variable cost refers to the margin of contribution per unit of sales or variable profit per unit.
This association has been deduced from the profit equation.
Here Profit = Revenues – Costs
Revenues = (Selling Price * Quantity of Product)
Costs = (Average Variable Costs * Quantity) + Total Fixed Costs
Profit = (Selling Price * Quantity)-(Average Variable Cost * Quantity + Total Fixed Costs)
The calculation of the quantity of product at the break even point when profit is equivalent to zero is as follows:
The quantity of product at break even = Total Fixed Costs/Selling Price – Average Variable Costs
If an item is not breaking even or a probable item distinctly indicates that it cannot be sold higher to the break even point, then the company may not sell or discontinue selling that item.
Last Updated on : 27th June 2013