Break-even analysis
In economics, business, and cost accounting, break-even analysis refers to the point at which total expenses and total revenue are equal. A break-even point analysis is performed to calculate how many units or dollars of revenue are required to cover total costs (fixed and variable costs). Break-even analysis comprises estimating and assessing an organization's margin of safety based on revenue and related costs. In other words, the study demonstrates how many sales are required to cover the cost of conducting an organisation. The margin of safety is an investment concept that states that an investor should only buy assets when their market price is much lower than their true worth. In other words, the margin of safety is the gap between the market price of an asset and the estimate of its underlying value.
The point at which total expenses and total income are equal is referred to as the break-even point.
A break-even point analysis is performed to calculate how many units or monetary value of revenue are required to cover total costs ( ie .fixed and variable costs)
The break-even analysis determines how many units of a product must be sold to cover the fixed and variable production costs.
The break-even point is used to calculate the margin of safety.
Break-even analysis is employed in a variety of contexts, ranging from stock and option trading to corporate budgeting for various business decision processes.
Example:
XYZ manufactures toys and in one period. The expected sales revenue is £160,000. The variable cost for producing each toy is £8 and the selling price is £16 each. The fixed costs of operating this aspect of the business are £40,000 per month.
Calculate the break-even point in terms of units and sales revenue.
Break even unit = Fixed Cost ÷ Contribution per unit
Contribution per unit = Sales – Variable cost
Contribution per unit= 16-8=8
Break even unit= 40000 ÷ 8 = 5000 unit
Break even sales = Fixed Cost ÷ PV ratio
PV ratio = Contribution ÷Sales
PV ratio = 8 ÷16 = 0.50
Break even sales= 40000 ÷ 0.50 = £ 80,000
proof 5000unit x 16 = 80,000
Margin of safety = {(Current Sales -Break even sales) ÷(Current Sales )} x 100
Margin of safety = {(160,000 - 80,000) ÷(160,000 )} x 100 = 50% or £80,000
i.e., if the sales reduce by up to 80,000 from 160,000 or 50% still be in break even point.