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Break Even Analysis and Calculations

I. Break Even Analysis

Determining the break even point for a business, or a specific proposed investment (project) within

a business, can be a useful business planning tool. The break even point may be thought of as the

point at which net profit equals zero.

Calculating break even is also referred to as cost-volume-profit analysis, contribution analysis or

sensitivity analysis. Break even analysis is sometimes referred to as cost-volume-profit analysis

because these are three key elements (i.e. cost, volume and profit) in the calculation. It is sometimes

referred to as contribution analysis because calculating break even requires determining how many

service or product contributions (selling price per unit minus variable costs per unit) are necessary to

cover, or pay for, the product's or project's expected fixed costs. It is sometimes referred to as

sensitivity analysis because changing one of the input variables allows us to see what difference the

change makes to break even volume, etc.

The break even point occurs when sales (revenue) equals expenses or costs. Costs are either

variable or fixed. Variable costs tend to vary directly with the number of units made or sold.

Examples include ingredients and packaging, sometimes labour (piece rate work), sometimes

transportation and sometimes sales commissions. Fixed costs tend to be relatively constant no

matter how many units are made or sold. Examples include rent, management salaries and

advertising.

Unit contribution is the amount of money remaining after the variable costs of producing or

purchasing one unit is subtracted from the selling price of one unit:

Selling price per unit – Variable costs per unit = Unit contribution

Total contribution is determined by multiplying unit contribution times the number of units sold.

Unit contribution x Number of units sold = Total contribution

A break even calculation example. A store sells t-shirts. The average selling price is $15 and the

average variable cost (cost price) is $9. Thus, every time the store sells a shirt it has $6

remaining after it pays the manufacturer. This $6 is referred to as the unit contribution. The

word contribution is appropriate since the $6 contributes to cover fixed costs and, once the fixed

costs are covered, the $6 contributes to profit. Suppose the fixed costs of operating the store (its

operating expenses) are $100,000 per year. The question then becomes how many contributions

of $6 are necessary to cover all fixed costs. The calculation is:

BSAD 102 – Business Decision-Making

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