Breakeven Analysis - Fixed Cost & Variable Cost, & Profit

Definition:

A breakeven analysis is used to determine how much sales volume your business needs to start , based on your fixed costs, variable costs, and selling price.

The breakeven analysis is often used in conjunction with a when developing a pricing strategy, either as part of a or a .

How to Do a Breakeven Analysis

To conduct a breakeven analysis, use this formula:

Fixed Costs divided by (Revenue per unit - Variable costs per unit)

So before you apply the formula you need to know:

Fixed Costs

Fixed costs are costs that must be paid whether or not any units are produced. These costs are "fixed" over a specified period of time or range of production. Examples of fixed costs include:

• over the contract period
• Startup loan payments (if you financed the )
• Property taxes
• Vehicle leases (or loan payments if the vehicle is purchased)
• Equipment (machinery, tools, computers, etc.)
• (if are on salary)
• Some utilities - for example, land line phone and internet charges may not change on a month to month basis
• Accounting fees

For an existing business fixed costs are readily available. For new businesses make sure to do your research and get the most accurate figures available.

Variable Costs

Unit variable costs are costs that vary directly with the number of products produced.

For instance, the cost of the materials needed and the labor used to produce units isn't always the same. Examples of variable costs include:

• Wages for commission-based employees (such as salespeople) or
• Utilities costs that increase with activity - for example, electricity, gas, or water usage
• Raw materials
• Shipping costs
• Equipment repair
• Sales costs (such as credit card processing fees, etc.)

Sample Breakeven Computation

Suppose that your fixed costs for producing 30,000 widgets are \$30,000 a year.

Your variable costs are \$2.20 materials, \$4.00 labour, and \$0.80 overhead, for a total of \$7.00.

If you choose a selling price of \$12.00 for each widget, then:

\$30,000 divided by (\$12.00 - 7.00) equals 6000 units.

This is the number of widgets that have to be sold at a selling price of \$12.00 to cover your costs. Each unit sold beyond 6000 generates \$5 profit.

 Fixed Costs for 30,000 widgets (per year) Business Lease \$15,000 Property Taxes \$5,000 Insurance \$4,000 Equipment \$3,000 Utilities \$3,000 Total Fixed Costs \$30,000 Variable Costs (per unit produced) Materials \$2.20 Labour \$4.00 Overhead \$.80 Total Variable Cost (Per Unit) \$7.00 Breakeven Selling Price Per Unit \$12.00 Selling price - variable costs \$5.00 #Units to sell/year to breakeven (\$30,000 / \$5.00) 6000 Profit Targets #Units to sell/year to generate \$10,000 profit 8000 #Units to sell/year to generate \$50,000 profit 16000

Using BreakEven Calculations

Breakeven analysis allows you to compute various "what if?" scenarios to reduce your breakeven point and increase profits:

• Increasing the selling price - in the above example, if you were able to by \$1 you would only need to sell 5000 units to break even (\$30,000 / (\$13 - \$7). Selling 6000 units would give you a profit of \$6000 (1000 units multiplied by \$6 cost per unit). However, in a highly competitive environment increasing the selling price is often not an option.
• - if you were able to reduce your fixed costs by \$5000 you would also reduce the breakeven point to 5000 units sold. Reducing and payroll are common ways for businesses to reduce fixed costs, as is relocating to other jurisdictions that have lower  or utilities costs.
• Reducing variable costs - reducing the variable costs by \$1 would also lower the breakeven point 5000 units.  Variable costs are typically lowered by reducing or labour costs, for example, a builder sourcing lumber from a lower-cost or taking advantage of equipment and/or technology to automate production.
• - assuming breakeven unit sales of 6000, increasing the number of units sold to 10000 would give a profit of \$20,000 (4000 units multiplied by \$5 cost per unit). This calculation can be used when considering the benefits of .  Say for example you decide to increase your advertising budget by \$5000 per year, which would raise your fixed costs to \$35,000. This would raise your breakeven unit sales to 7000 - anything less means your was not successful.

Examples: Alison used a breakeven analysis to determine what prices she should set for her software products.