Breakeven Point Analysis:
Contents:

Definition and Explanation

Calculation by equation
method

Calculation by
contribution margin method

Advantages

Limitations

Review problem
Breakeven point
is the level of sales at which profit is zero. At break even
point total sales are equal to total cost (variable
+ fixed).
If a firm cannot manage sales
to cover variable as well as fixed costs it will have to bear
losses. The following is the further explanation of
this concept:
Profit 
Sales > Variable Expenses +
Fixed Expenses 

Breakeven Point 
Sales = Variable Expenses +
Fixed Expenses 

Loss 
Sales < Variable Expenses +
Fixed Expenses 

There are two
methods for the calculation of breakeven point.
These are:
 Equation
method
 Contribution
margin method
We can use the
following equation to calculate breakeven point:
Profit = Sales  (Variable expenses + Fixed
expenses)
or
Sales = Variable expenses + Fixed expenses + Profit
When breakeven
point is calculated using above equation profit is
taken as zero because breakeven is that level of
sales where sales are equal to total cost (variable
+ fixed) and profit is zero.
Example:
We can
use the following data to calculate breakeven
point.

Sales price per unit = $500

variable cost per unit = $300

Total fixed expenses = $70,000
Required:
Calculate breakeven point using equation method.
Solution:
Sales = Variable expenses + Fixed expenses + Profit
$500Q* = $300Q*
+ $70,000 + $0**
$200Q = $70,000
Q =
$70,000/$200
Q =
350 Units
Q*
= Number (Quantity) of units sold.
**The break even point
can be computed by finding that point where profit
is zero
Graphical
Representation (Breakeven Chart
 CVP Graph):
The break even
point in sales dollars can be computed by
multiplying the break even level of unit sales by
the selling price per unit.
350
Units × $500 Per unit = $175,000
Under this method
total fixed cost is divided by unit contribution
margin. The resulting figure is number of units to
be sold to breakeven (no profit, no loss).
Example:
We can
use the following data to calculate breakeven
point.

Sales price per unit = $500

variable cost per unit = $300

Total fixed expenses = $70,000
Required:
Calculate breakeven point using contribution margin
method.
Solution:
Breakeven point in units = Fixed expenses / Unit
contribution margin
$70,000 / $200*
350
Units
*$500 (Sales) − $300
(Variable exp.)
Break even point in
sales:
350
Units × $500 Per unit
= $175,000
Equation method and
contribution margin methods are equivalent.
Contribution margin method is actually a shortcut
conversion of equation method.
The following
formula is also extensively used to calculate break
even point:
Breakeven Sales in Dollars = [Fixed Cost / 1 –
(Variable Cost / Sales)]
This formula
produces the same answer:
Break Even Point = [$70,000 / 1 – (300 / 500)]
=
$70,000 / 1 – 0.6
=
$70,000 / 0.4
=
$175,000
Number of units to be sold to
break even:
$175,000 / $500
= 350 units
Following are some of the main
advantages of break even analysis:
 It explains the
relationship between cost, production, volume and returns.
 It can be extended to show
how changes in fixed cost, variable cost, commodity prices,
revenues will effect profit levels and break even points.
Break even analysis is most useful when used with partial
budgeting, capital budgeting techniques.
 The major benefits
to use break even analysis is that it indicates the lowest
amount of business activity necessary to prevent losses.
Break even analysis is best
suited to the analysis of one product at a time. It may be
difficult to classify a cost as all variable or all fixed; and
there may be a tendency to continue to use a break even analysis
after the cost and income functions have changed.
Voltar Company
manufactures and sells a telephone answering
machine. The company's contribution format income
statement for the most recent year is given below:

Total 
Per unit 
Percent of
sales 
Sales 
$1,200,000 
$60 
100% 
Less variable
expenses 
900,000 
45 
?% 




Contribution
margin 
300,000 
15 
?% 
Less fixed
expenses 
240,000 






Net operating
income 
$60,000 






Required:
Calculate breakeven point both in units and sales
dollars. Use the equation method.
Solution:
Sales = Variable expenses + Fixed expenses +Profit
$60Q
= $45Q + $240,000 + $0
$15Q
= $240,000
Q =
$240,000 / 15 per unit
Q =
16,000 units; or at $60 per unit, $960,000
Alternative
solution:
X =
0.75X + 240,000 + $0
0.25X = $240,000
X =
$240,000 / 0.25
X =
$960,000; or at $60 per unit, 16,000 units
Relevant Articles:
