Break-Even Analysis is a very useful cost accounting technique. This analysis is part of an analytical model called cost-volume-profit (CVP) analysis and helps you determine how much product your company needs to sell to cover its costs and start making a profit. Follow these steps to learn how.
Step
Part 1 of 3: Determining Costs and Prices
Step 1. Determine the firm's fixed costs
Fixed costs are costs that do not depend on the volume of production. Rent, insurance, property taxes, loan payments, and other utility costs (such as water and electricity) are examples of fixed costs because the amount paid is the same regardless of how many units of production are produced or sold. Group the company's fixed costs over a certain period and then add them up.
Step 2. Calculate the firm's variable costs
Variable costs are costs whose amount depends on the volume of production. For example, a business unit that offers oil change services must purchase an oil filter every time an oil change is performed. Therefore, the cost of the oil filter is a variable cost. In fact, this cost can be allocated to each oil change because each time the oil change, the company is required to buy one oil filter.
Examples of other variable costs include raw materials, commission fees, and freight
Step 3. Determine the price of the desired product
Pricing strategies are part of a more comprehensive and complex marketing strategy. However, the selling price must exceed the cost of production, so you must know the actual total cost (in fact, there are regulations prohibiting the sale of goods below the cost of production).
- Other pricing strategies include knowing the target market's price sensitivity (whether the customer has a high or low income), competitors' prices, and product feature comparisons, and calculating the revenue needed to generate profits and grow the business.
- Remember that sales are not affected by price alone. Buyers will also pay for a product of equal value. Your goal is to increase market share so that you can determine the price.
Part 2 of 3: Calculating Contribution Margin and Break-Even Points
Step 1. Calculate the contribution margin per unit
The contribution margin per unit determines the amount of money a unit makes after covering its fixed costs. This margin is calculated by subtracting the unit variable cost from the selling price. For clarity, take a look at the example below.
- The price of an oil change is IDR 400,000 (remember, this calculation can only be done if the currency is the same). Each oil change has 3 cost elements: the cost of purchasing an oil filter of Rp. 50,000, the purchase of an oil can of Rp. 50,000, and payment of a technician's salary of Rp. 100,000. The three costs are variable costs associated with oil changes.
- The contribution margin for one oil change is IDR 400,000-(IDR 50,000 + IDR 50,000 + IDR 100,000) which is IDR 200,000. The oil change service gives the company $200,000 in revenue after covering its variable costs.
Step 2. Calculating Contribution Margin Ratio
This ratio will provide a percentage that can be used to determine the profit to be generated from various levels of sales. To calculate the contribution margin ratio, divide the contribution margin by sales.
Let's use the previous example. Share the contribution margin of IDR 200,000 with the selling price of IDR 400,000. The result is a contribution margin ratio of 50%
Step 3. Calculating the company's Break-Even Point
The Break-Even point indicates the amount of sales volume that needs to be achieved to cover all costs. The formula is to divide all fixed costs by the contribution margin of the product.
From the previous example, let's say the company's fixed costs in a month are Rp. 20,000,000. Thus, the company's break-even point is 20,000,000 / 200,000 = 10 units. This means that an oil change service needs to be performed 100 times a month to cover the entire cost (the company's break-even point)
Part 3 of 3: Calculating Profit and Loss
Step 1. Determine the estimated loss or profit
Once you know the company's break-even point, you can estimate the company's profit. Remember, each unit sold will generate as much revenue as its contribution margin. Thus, each unit sold above the break-even point will generate a profit and each unit sold below the break-even point will result in a loss of as much as the contribution margin.
Step 2. Calculate the estimated profit
From the previous example, let's say the company provides 150 oil changes per month. To reach the break-even point, only 100 oil changes are needed. Thus, the remaining 50 oil changes will generate a profit of IDR 200,000 per one oil change so that the total profit is 50 x IDR 200,000 of IDR 10,000,000 per month.
Step 3. Calculate the estimated loss
Now, let's say the company only provides oil changes 90 times a month. The break-even point was not reached, so the company suffered a loss. Every 10 oil changes below the break-even point will result in a loss of IDR 200,000 for a total (10 * IDR 200,000) of IDR 2,000,000 a month.
