Break-even analysis, a subset of cost-volume-profit (CVP) analysis, is used by

management to help understand the relationships between cost, sales volume

and profit. This techniques focuses on how selling prices, sales volume, variable
costs, fixed costs and the mix of product sold affects profit. Understanding some
of the basic tenets of CVP analysis can help you analyze these factors in your
business and make better business decisions.

CVP analysis is most often used to determine a company's break-even point. This
is the level of sales where the company will not incur a loss, yet not make a
profit. To calculate the break-even point, you must first calculate the
contribution margin. The contribution margin is a company's sales less its variable
expenses. Then, divide the company's fixed costs by the contribution margin.
This will give you the company's break-even point in total dollars of sales. If you
want to calculate the break-even point in units sold, replace the contribution
margin in the denominator with the contribution margin per unit. The
contribution margin per unit is calculated as the sales price less the variable cost
per unit.

Break-even analysis can be approached in two ways:

 Equation method

 Contribution margin method.

Equation Method

Profits = Sales – (Variable expenses + Fixed expenses) or Sales = Variable

expenses + Fixed expenses + Profits (At the break-even point profits equal zero)

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For example:

Total Per Unit Percent

Total Per Unit Percent
Sales (500 wallets) 250,000 500 100%
Sales (500 wallets) 250,000 500 100%
Less: variable expenses 150,000 300 60%
Less: variable expenses 150,000 300 60%
Contribution margin 100,000 200 40%
Contribution margin 100,000 200 40%
Less: fixed expenses 80,000
Less: fixed expenses 80,000
Net income 20,000
Net income 20,000

We calculate the break-even point as follows:

Sales = Variable expenses + Fixed expenses + Profits
Where: Q = Number of wallets sold
P500 = Unit sales price
P300 = Unit variable expenses
P80,000 = Total fixed expenses
P500Q = P300Q + P80,000 + P0
P200Q = P80,000
Q = 400 wallets

Contribution Margin Method

The contribution margin method is a variation of the equation method.

Break-even point = Fixed expenses

in units sold Unit contribution margin

Break-even point in = Fixed expenses

total sales dollars CM ratio

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CVP Relationships in Graphic Form

Viewing CVP relationships in a graph gives managers a perspective that can be

obtained in no other way. Consider the following information for Wind Co.:

Income
Income Income
Income Income
Income
300
300units
units 400
400units
units 500
500units
units
Sales
Sales 150,000
150,000 200,000
200,000 250,000
250,000
Less:
Less:variable
variableexpenses
expenses 90,000
90,000 120,000
120,000 150,000
150,000
Contribution margin
Contribution margin 60,000
60,000 80,000
80,000 100,000
100,000
Less: fixed expenses
Less: fixed expenses 80,000
80,000 80,000
80,000 80,000
80,000
Net
Netincome
income(loss)
(loss) (20,000)
(20,000) -- 20,000
20,000

CVP Graph

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Target Profit Analysis

Suppose Wind Co. wants to know how many bikes must be sold to earn a profit
of 100,000.
We can use our CVP formula to determine the sales volume needed to achieve
a target net profit figure.
Sales = Variable expenses + Fixed expenses + Profits
P500Q = P300Q + P80,000 + P100,000
P200Q = P180,000
Q = 900 wallets

The Contribution Margin Approach

We can determine the number of bikes that must be sold to earn a profit of
100,000 using the contribution margin approach.

Units sold to attain = Fixed expenses + Target profit

the target profit Unit contribution margin

80,000 + 100,000 = 900 wallets

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