Break-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost.
It determines what level of sales is required to cover the total cost of business (Fixed as well as variable cost). It shows us how to calculate the point or juncture when a company would start to make a profit.
The calculation of break-even analysis may use two equations:
In the first approach, we have to divide the fixed cost by contribution per unit
Break-Even Point (Qty) = Total Fixed Cost / Contribution per Unit
Where, Contribution per Unit = Selling Price per Unit – Variable Cost per Unit
In the second approach, we have to divide the fixed cost by contribution to sales ratio or profit-volume ratio
Break-Even Sales (Rs) = Total Fixed Cost / Contribution Margin Ratio
Where Contribution Margin Ratio = Contribution per Unit / Selling Price per Unit
Advantages
Some of the advantages of break-even analysis are as follow:
It helps you to identify missing expenses
It helps you to set targets for revenue
It helps the decision making
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Break even analysis