Break-even, (the point at which your business will achieve zero gain or loss) is a foundational topic in finance and accounting. This point can be expressed in dollars or units. Break-even analysis is the process of identifying these numbers. There are five different components that are generally used to identify a break-even point.
The first component of break-even is the selling price (SP). The selling price is simply the dollar amount that is charged per unit.
The second piece of break-even is variable costs (VC), which is expressed per unit. These costs are the expenses that vary with the number of units that are produced. They generally include direct materials, direct labor and manufacturing overhead.
Contribution margin is the third concept of break-even. It is equal to the selling price less variable costs. Contribution margin tells how much profit you are making per additional item produced.
Fixed costs are the fourth part of break even analysis. These costs do not change based on the activity level of your company.
The final component of break even analysis is units. Simple break-even analysis assumes that you sell 100% of the units that are produced.
Once you have these components, it is easy to determine a break-even point. The objective is to identify where total revenue equals total costs.
To begin, set break-even units equal to X. Your revenue will be equal too your selling price times the number of units that you sell. Your total costs will be equal to your variable cost per unit times the number of units you are selling, plus any fixed costs. When you set total revenue = total cost, you are left with this formula: SP(X) = VC(X) + FC.
Solving this formula will give you the number of units you must sell to break-even. To find this value in dollars, simply multiply the number of units times the selling price. SP(X) = Break-even dollars.
For a simple example:
Selling Price = $10
Variable Costs = $5
Contribution Margin = $5
Fixed Costs = $100
SP(X) = VC(X) + FC
10X = 5X + 100
5X = 100
X = 20 units to break-even
10(20) = $200 to break-even