Breakeven Analysis - Fixed & Variable Costs, & Profit

How to Find Your Business's Profit Point

Profit Loss
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Definition:

A breakeven analysis is used to determine how much sales volume your business needs to start making a profit.

The breakeven analysis is often used in conjunction with a sales forecast when developing a pricing strategy, either as part of a marketing plan or a business plan.

How to Do a Breakeven Analysis

To conduct a breakeven analysis, use this formula:

Fixed Costs divided by (Revenue per unit - Variable costs per unit)

Fixed Costs

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. Examples of fixed costs include:

Variable Costs

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

  • Wages for commission-based employees (such as salespeople) or contractors

Sample Breakeven Computation

 Suppose that your fixed costs for producing 100,000 widgets were $30,000 a year.

Your variable costs are $2.20 materials, $4.00 labour, and $0.80 overhead, for a total of $7.00.

If you choose a selling price of $12.00 for each widget, then:

$30,000 divided by ($12.00 - 7.00) equals 6000 units.

This is the number of widgets that have to be sold at a selling price of $12.00 before your business will start to make a profit.

Using BreakEven Calculations

Breakeven analysis allows you to compute various "what if?" scenarios to reduce your breakeven point and increase profits:

  • Increasing the selling price - in the above example, if you were able to increase the selling price by $1 you would only need to sell 5000 units to break even ($30,000 / ($13 - $7). Selling 6000 units would give you a profit of $6000 (1000 units * $6 cost per unit).
  • Reducing your fixed costs - if you were able to reduce your fixed costs by $5000 you would also reduce the breakeven point to 5000 units sold. Reducing rent and payroll are common ways for businesses to reduce fixed costs, as is relocating to other jurisdictions that have lower business taxes.
  • Reducing variable costs - reducing the variable costs by $1 would also lower the breakeven point 5000 units.  Variable costs are typically lowered by reducing material or labour costs, for example, a builder sourcing lumber from a lower-cost supplier or taking advantage of equipment and/or technology to automate production.
  • Increasing sales - assuming breakeven unit sales of 6000, increasing the number of units sold to 10000 would give a profit of $20,000 (4000 units * $5 cost per unit). This calculation can be used when considering the benefits of advertising.  Say for example you decide to increase your advertising budget by $5000 per year, which would raise your fixed costs to $35,000. This would raise your breakeven unit sales to 7000 - anything less means your ad campaign was not successful.

 

Examples: Alison used a breakeven analysis to determine what prices she should set for her software products.

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