3.2 Calculate a Break-Even Point in Units and Dollars
3 min read•june 18, 2024
Break-even analysis is a crucial tool in managerial accounting. It helps businesses determine the point at which equals total costs, resulting in zero profit. This analysis is essential for making informed decisions about pricing, production volumes, and profit targets.
The concept applies to both manufacturing and service industries. By calculating the and , managers can determine the sales volume needed to cover costs and achieve desired profits. This information is vital for strategic planning and financial forecasting.
Break-Even Analysis
Break-even calculation methods
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- (BEP) occurs when total revenue equals total costs resulting in zero profit
- per unit (CM per unit) represents the amount each unit sold contributes to covering and generating profit
- CM per unit calculated as sales price per unit minus variable cost per unit
- (CM ratio) expresses the percentage of each sales dollar that contributes to covering fixed costs and generating profit
- CM ratio calculated as (sales price per unit minus variable cost per unit) divided by sales price per unit
- BEP in units calculated as fixed costs divided by CM per unit
- BEP in sales dollars calculated as fixed costs divided by CM ratio
Sales volume for target profit
- represents the desired level of profit to be achieved
- Required sales in units to achieve a target profit calculated as (fixed costs plus target profit) divided by CM per unit
- Required sales in dollars to achieve a target profit calculated as (fixed costs plus target profit) divided by CM ratio
Break-even analysis applications
- Manufacturing organizations have including (15), and (60,000), , and ($30,000)
- Service organizations have variable costs including (5) and fixed costs including fixed overhead (60,000)
- Break-even analysis principles remain consistent for both manufacturing and service organizations:
- Determine the contribution margin per unit or
- Calculate the break-even point in units or sales dollars
- Determine the sales volume required to achieve a target profit
Applying Break-Even Analysis
Break-even calculation methods
- Example: A company sells a product for 60 per unit and fixed costs of $120,000
- CM per unit equals 60 which is $40
- CM ratio equals (60) divided by $100 which is 0.4 or 40%
- BEP in units equals 40 which is 3,000 units
- BEP in sales dollars equals 300,000
- Total revenue at break-even point can be calculated by multiplying BEP in units by the selling price
Sales volume for target profit
- Example: Using the same company from the previous example, the target profit is $60,000
- Required sales in units equals (60,000) divided by $40 which is 4,500 units
- Required sales in dollars equals (60,000) divided by 0.4 which is $450,000
- can be calculated by dividing the target profit by the required sales in dollars
Break-even analysis applications
- Example for a manufacturing company:
- A manufacturer produces a product with a selling price of 50, and fixed costs of $90,000
- CM per unit equals 50 which is $30
- BEP in units equals 30 which is 3,000 units
- Example for a service company:
- A service company provides a service for 40 and fixed costs of $160,000
- CM per unit equals 40 which is $80
- BEP in equals 80 which is 2,000 hours
Advanced Break-Even Concepts
Cost-Volume-Profit Analysis
- Extends break-even analysis to examine how changes in volume affect profit
- Considers the impact of on variable and fixed costs
- Helps in understanding and its effect on profitability
Key Terms to Review (31)
Administrative Expenses: Administrative expenses are the costs incurred by a business for its day-to-day operations and management, excluding the direct costs of manufacturing or providing a service. These expenses are necessary for the overall administration and oversight of the organization, rather than being directly tied to the production or delivery of the company's products or services.
Break-Even Formula: The break-even formula is a mathematical equation used to determine the point at which a company's total revenue equals its total costs, meaning it has neither a profit nor a loss. This formula is essential for understanding the relationship between a company's fixed costs, variable costs, and sales volume in order to make informed business decisions.
Break-even point: The break-even point is the level of sales at which total revenues equal total costs, resulting in zero profit. It can be calculated in both units and dollars to determine the required sales volume or revenue needed to cover all fixed and variable costs.
Break-Even Point: The break-even point is the level of sales or production at which a company's total revenue exactly equals its total costs, resulting in neither a profit nor a loss. It is the point where a company's fixed and variable costs are covered by its sales revenue.
Common fixed costs: Common fixed costs are fixed costs that support more than one business segment. These costs do not change with the level of production or sales and cannot be traced directly to any single segment.
Contribution margin: Contribution margin is the amount remaining from sales revenue after variable expenses have been deducted. It is used to cover fixed expenses and contribute to profits.
Contribution Margin: Contribution margin is the amount of revenue that remains after deducting the variable costs associated with producing a product or service. It represents the portion of sales revenue that contributes to covering fixed costs and generating profit. This concept is crucial in understanding the financial performance and decision-making processes of organizations, whether they are merchandising, manufacturing, or service-based entities.
Contribution margin ratio: The contribution margin ratio is the percentage of each sales dollar that remains after deducting variable costs. It helps in understanding how sales affect profitability.
Contribution Margin Ratio: The contribution margin ratio is a metric that measures the proportion of each dollar of sales revenue that contributes to covering a company's fixed costs and generating profit. It represents the percentage of sales revenue that remains after deducting the variable costs associated with producing and selling the product or service.
Cost-volume-profit (CVP) analysis: Cost-Volume-Profit (CVP) analysis is a managerial accounting tool used to determine how changes in costs and volume affect a company's operating income and net income. It helps managers make decisions about pricing, production levels, and product mix by analyzing the relationships among cost, volume, and profit.
Cost-Volume-Profit Analysis: Cost-Volume-Profit (CVP) analysis is a managerial accounting technique that examines the relationship between a company's costs, volume of output, and profitability. It provides insights into how changes in these factors can impact a business's overall financial performance, helping managers make informed decisions.
Direct labor: Direct labor refers to the wages and salaries of employees who are directly involved in the production of goods or services. This cost is directly traceable to specific products or jobs within a manufacturing environment.
Direct Labor: Direct labor refers to the cost of the workforce directly involved in the production of goods or the provision of services. It encompasses the wages and salaries paid to employees who physically transform raw materials into finished products or perform tasks that are essential to the completion of a service.
Direct materials: Direct materials are raw materials that can be directly traced to the production of a specific product. These materials are essential components in manufacturing and are included in the cost of goods sold.
Direct Materials: Direct materials are the raw materials that can be directly traced to the production of a specific product. They are a key component of product costs, along with direct labor and manufacturing overhead, and are a crucial element in understanding the differences between merchandising, manufacturing, and service organizations, as well as the various costing methods used in managerial accounting.
Economies of Scale: Economies of scale refer to the cost advantages that businesses can exploit by expanding their scale of production. As a company increases its output, its average costs per unit typically decrease due to more efficient utilization of resources and processes.
Fixed Costs: Fixed costs are expenses that remain constant regardless of the level of production or sales activity within a business. These costs do not fluctuate with changes in output or revenue and must be paid regardless of the company's performance.
Fixed Manufacturing Overhead: Fixed manufacturing overhead refers to the indirect costs associated with the manufacturing process that do not vary with changes in production volume. These costs remain constant regardless of the number of units produced, and they must be incurred to maintain the manufacturing facility and support the overall production operations.
Operating leverage: Operating leverage measures how a company's operating income changes with respect to sales volume changes. It indicates the proportion of fixed costs in a company's cost structure, impacting profitability.
Operating Leverage: Operating leverage refers to the degree to which a company's costs are composed of fixed costs versus variable costs. It measures the sensitivity of a company's operating income to changes in its sales volume. Operating leverage is a critical concept in understanding a company's profitability, break-even point, and ability to withstand fluctuations in demand.
Profit Margin: Profit margin is a financial metric that measures the percentage of revenue that a company retains as profit after accounting for all expenses. It is a crucial indicator of a company's profitability and efficiency in generating earnings from its operations.
Profit margin percentage: Profit margin percentage is a financial metric that shows the percentage of revenue that exceeds the costs of producing goods or services. It indicates how efficiently a company is managing its expenses relative to its revenue.
Selling Expenses: Selling expenses are the costs incurred by a business in the process of marketing, promoting, and selling its products or services to customers. These expenses are directly related to the sales function and are essential for generating revenue and maintaining a company's competitive position in the market.
Service Hours: Service hours refer to the amount of time an individual or organization dedicates to providing voluntary, unpaid assistance or support to a community or charitable cause. This term is particularly relevant in the context of calculating a break-even point, as service hours can be a significant factor in determining the profitability and sustainability of a service-based business.
Service hours are an important consideration when analyzing the break-even point, as they represent the labor and resources required to deliver a service to customers or clients. By understanding the service hours needed to meet demand, businesses can more accurately forecast their revenue, expenses, and ultimately, their break-even point.
Target Profit: Target profit is the desired level of profit that a business aims to achieve through its operations. It is a critical concept in managerial accounting, as it helps organizations set financial goals, make informed decisions, and evaluate their performance.
Total Revenue: Total revenue is the total amount of money a business earns from selling its products or services. It represents the overall income generated by a company's operations and is a crucial metric in understanding a business's financial performance and profitability.
Total variable costs: Total variable costs are the overall expenses that change in direct proportion to the level of production or sales volume. These costs increase as production increases and decrease as production decreases.
Unit contribution margin: Unit contribution margin is the amount each unit sold contributes towards covering fixed costs after variable costs are subtracted. It is calculated as the selling price per unit minus the variable cost per unit.
Unit Contribution Margin: The unit contribution margin is the amount of revenue generated from the sale of a single unit of a product that contributes to covering the fixed costs and generating profit. It represents the difference between the selling price per unit and the variable cost per unit.
Variable Costs: Variable costs are expenses that fluctuate directly with changes in a company's production or sales volume. These costs increase or decrease in proportion to the level of business activity, unlike fixed costs which remain constant regardless of output. Understanding variable costs is crucial for analyzing cost behavior patterns, calculating contribution margin, and making informed business decisions.
Variable Manufacturing Overhead: Variable manufacturing overhead refers to the indirect production costs that fluctuate in proportion to changes in the level of production activity. These costs vary with the volume of goods produced and include items such as indirect materials, indirect labor, and variable factory utilities.