Break-even analysis or cost-volume-profit analysis (CVP) refer to calculating a level at which total revenue is equal to total cost.

Operating break-even point refers to the sales level at which all operating costs are covered and at which point operating profit (EBIT) equals zero.

To find operating break-even point we need to follow the formula:

Q=FC/P-VC

Where:

Q – is operating break-even point (in units)

FC – is fixed cost

P – is price

VC – is variable cost.

Fixed costs refer to costs which do not change as volume of sales changes. For example, assume that enterprise is renting a building. The rent paid is a fixed cost since it does not fluctuate with changes in sales volume. Even if company will not sale any products over certain period, the rent still will have to be paid.

Variable costs, on the other hand, refer to costs which fluctuate with changes in sales volume. An example of variable cost is commission paid to sales personnel. For example, assume that business sales product at $100 per unit and pays sales commission of $5 to its sales personnel. The sales commission is a variable cost since it will fluctuate with changes in sales volume.

Test yourself:

Assume that ABC’s fixed cost is $800,000. The company manufactures only one product with price per unit of $25 and variable cost per unit of $15. What is the amount of units that company need to manufacture to have just enough income to cover its operating costs?

Solution:

Q=800,000/25-15

Q=80,000 units

Therefore, ABC needs to manufacture 80,000 units to break even

Test yourself:

ABC company produce only one product with sales price per unit of $15. Its fixed cost is $3,800 and its variable cost is $8. Find operating break-even point.

Solution:

Follow the formula Q=FC/P-VC.

Q=3,800/15-8

Q=543 units

This means that at 543 units, ABC’s operating profit will be zero. At any amount of units above 543 the company will have positive operating profit (above zero). At any point below 543 units the company will have negative operating profit (below zero, which we can also call a loss).

To find overall break-even point, we need to find sales level at which all the costs are covered.