From there, you can decide whether further analysis is needed.Get the Guide What is a Sales Commission Structure? For example, what portion of executive salaries should you use? Break-Even Analysis also doesn't consider cash flow or how the proposed project might affect economies of scale, nor does it take into account the value of money as it varies with time.įor these reasons and many others, Break-Even Analysis is most often used in the early stages of thinking about a decision.
Material costs and other costs can change dramatically, and it's not always clear which fixed costs should be included. Cost and revenue calculations can be much more complex than those considered in a Break-Even Analysis. What is the opportunity cost of spending $900,000 on the equipment as a capital expense, as opposed to investing the money in something else? Would another product give a better Return on Investment (RoI)?īreak-Even Analysis is also very restrictive in what it includes in the equation. In our example, there are many other issues to consider. Limitations of Break-Even AnalysisĪ Break-Even Analysis is best used as a preliminary planning tool. For example, how much would the break-even point increase if you reduced the price to $105? This should increase the sales volume, but would that compensate enough for the lower price? Using the break-even point, you can manipulate a variety of costs and revenue variables to understand the effects of various scenarios.
This is below the minimum sales volume that the sales team thinks they can achieve, so the product has a good chance of making money.īreak-Even Analysis can also be useful in thinking about pricing. The break-even point is 385 units per month.
To calculate the break-even point, use this equation: You need to decide if the product is financially viable. The equipment you'll need to produce the product costs $900,000 and this will be spread over three years, giving you a fixed cost of $25,000 per month. Market research has shown that customers will pay $115 for it, and your sales team is confident that they can sell at least 500 units per month. Let's imagine that you're considering launching a new product. N = (FC + Profit)/(P – VC) A Break-Even Example If you have a specific profit target, you can use the break-even equation to calculate the number of units you must sell to achieve that target: Solving for n gives you the number of units you need to break even: You can calculate the break-even point by expanding the break-even equation: Total revenue is the price charged per unit multiplied by the number of units produced or sold: TR = n x P, where P equals the unit price.Īgain, you can see the line for Total Revenue in figure 1, with break-even occurring where the TR line crosses the TC line. You can see how these costs vary with the number of units sold in figure 1, below: