# How to Do Break Even Analysis

Three Parts:Determining Costs and PricesCalculating Contribution Margin and Break-Even PointCalculating Profits and Losses

Break-even analysis is a very useful cost accounting technique. It is part of a larger analytical model called cost-volume-profit (CVP) analysis, and it helps you determine how many product units your company needs to sell to recover its costs and start realizing profit. Learning how to do a break-even analysis is a matter of following a few steps.

## Steps

### Part 1 Determining Costs and Prices

- 1
**Determine your company's fixed costs.**Fixed costs are any costs that don't depend on the volume of production. Rent, insurance, property taxes, loan payments and utilities would be examples of fixed costs, because you will pay the same amount for them no matter how many units you produce or sell. Categorize all your firm's fixed costs for a given period and add them together.^{[1]} - 2
**Calculate your company's variable costs.**Variable costs are those that will fluctuate along with production volume. For example, a business that performs oil changes will have to purchase more oil filters if they perform more oil changes, so the cost of buying oil filters is a variable cost. In fact, because the company can expect to buy 1 oil filter per oil change, this cost can be allocated to each oil change performed.^{[2]}- Other examples of variable costs include raw materials, commissions paid to sales people, freight in and freight out.

- 3
**Determine the price at which you will sell your product.**Pricing strategies are part of a much more comprehensive marketing strategy, and can be fairly complex. However, you know that your price must be at least as high as your production costs, so knowing your true costs is important. (In fact, a lot of anti-trust legislation exists to outlaw selling below cost).^{[3]}- Other pricing strategies include knowing the price sensitivity of your target market (high income or low income customers), finding out what competitors are charging and comparing product features, and calculating how much revenue you need to generate a profit and expand the business.
- Remember price by itself does not drive sales. People will pay for good value. Your goal is to increase your market share so you can then be the price driver.

### Part 2 Calculating Contribution Margin and Break-Even Point

- 1
**Calculate your unit contribution margin.**The unit contribution margin represents how much money each unit sold brings in after recovering its own variable costs. It is calculated by subtracting a unit's variable costs from its sales price. Consider the following example using an oil change business.^{[4]}- The sales price of an oil change is $40 (note that these calculations will work equally well when expressed in other currencies). Each oil change has 3 costs associated with it: purchasing a $5 oil filter, purchasing a $5 can of oil, and paying $10 in wages to the technician performing the oil change. These are the variable costs associated with an oil change.
- The contribution margin for a single oil change is: $40 - (5 + 5 + 10) or $20. Providing an oil change to a customer brings the company $20 in revenue after recovering its own variable costs.

- 2
**Calculate the contribution margin ratio.**This will give you a percentage that can be used to determine the profits that will result from various sales levels. To calculate the contribution margin ratio, divide the contribution margin by sales.^{[5]}- Using the example above, divide the contribution margin of $20 by $40 sales price. The result is a contribution margin ratio of 50%.

- 3
**Calculate your company's break-even point.**The break-even point tells you the volume of sales you will have to achieve to cover all of your costs. It is calculated by dividing all your fixed costs by your product's contribution margin.^{[6]}- Using the example above, imagine all of your company's fixed costs for a given month are $2000. Therefore, the break-even point is: 2000 / 20 = 100 units. When 100 oil changes have been performed in a month, the company "breaks even."

### Part 3 Calculating Profits and Losses

- 1
**Determine your expected profits or losses.**Once you have calculated the break-even volume, you can estimate your expected profits. Remember that each additional unit sold will produce revenue equal to its contribution margin. Therefore, each unit sold above the break-even point will produce a profit equal to its contribution margin, and each unit sold below the break-even point will generate a loss equal to its contribution margin.^{[7]} - 2
**Calculate projected profits.**Using the example above, imagine your business provides 150 oil changes in a month. Only 100 oil changes were needed to break even, so the additional 50 oil changes will generate a profit of $20 each, for a total of (50 * 20) or $1000.^{[8]} - 3
**Calculate projected losses.**Now imagine your business provided only 90 oil changes in a month. You didn't achieve your break-even volume, so you sustained a loss. Each of the 10 oil changes under your break-even volume generated a loss of $20, for a total of (10 * 20) or $200.^{[9]}

## Tips

- Make sure that you understand the limitations of break-even analyses. Because they rely on cost and volume estimates, they won't ever be able to produce a perfectly accurate profit or loss figure.

## Things You'll Need

- Calculator

## Sources and Citations

- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html
- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html
- ↑ http://www.inc.com/guides/price-your-products.html
- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html
- ↑ http://www.accountingtools.com/contribution-margin-ratio
- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html
- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html
- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html
- ↑ http://www.accountingcoach.com/online-accounting-course/01Xpg01.html

## Article Info

Categories: Accounting and Regulations