Break-Even Analysis

Financial PlanNing & Funding: Lesson 6

College of Business professor, Mike Porten, discusses the use of break-even analysis within your business.

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Video Lesson Topics

- Income Statement

The primary components of a typical income statement start with the following:

Total Revenues or Sales- This equals the total amount of funds derived from a product or service sold.
Cost of Goods Sold- This includes all direct costs incurred to produce your product or service sold. Direct costs will fluctuate up or down as production changes. Labor and raw materials are examples of direct costs.
Gross Profit- The gross profit is total total sales or revenues minus direct costs. It is called gross profit because additional expenses must be subtracted to calculate an operating profit.
Operating Expenses- Operating expenses are incurred from selling and general administrative costs; these include indirect costs that were indirectly required to produce your product or service. Indirect costs will not change as production changes. Clerical work and rent are examples of indirect costs.
Operating Profit- This equals total revenues or sales minus cost of goods sold minus other expenses.

- Break-Even Analysis

Break-even analysis is a method used to determine how many units of a product or service must be sold to cover the fixed and variable costs of production and where profitability begins. This helps companies determine how many units need to be sold to cover all of their costs and expenses. Break-even analysis will be used by all business owners to determine the price they need to charge to cover their variable and fixed costs. The equation to find revenue is total fixed costs plus total variable costs. Total fixed costs refers to a cost of doing business that does not change with an increase or decrease in the number of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company independent of any specific business activities. This means that fixed costs are generally indirect, and that they do not apply directly to a company’s production of any goods or services. Rental or lease payments, administrative salaries, insurance, property taxes, and interest are all examples of fixed costs.

Total variable costs refer to a cost of doing business that changes in proportion to how much a company produces or sells. Variable costs increase or decrease depending on a company’s production or sales volume; they rise as production increases and fall as production decreases.

- Calculating Break-Even Output

Break-even output is calculated by fixed costs divided by selling price per unit minus variable costs per unit (fixed costs/selling price per unit – variable costs per unit).

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