Break even analysis

Summary

This video on break-even analysis explains how to determine the sales volume at which a business neither makes a profit nor incurs a loss. It covers definitions, graphical representation, and formulas to calculate the break-even point. Using an example, it illustrates how fixed costs and contribution margins affect profitability. The video also offers practical advice for business owners to improve profitability by increasing sales volume, reducing fixed costs, increasing prices, or lowering variable costs. For more insights on business, finance, and investing, viewers are encouraged to subscribe to the Finance Storyteller YouTube channel.

Takeaways

• 📈 The break-even point is the sales volume where neither profit nor loss is made.
• 💰 Another way to define it is where the Contribution Margin equals the Fixed Costs.
• 📊 The break-even point can be visually represented on a graph where the lines for Contribution Margin and Fixed Costs intersect.
• 🔢 Contribution Margin is calculated as revenue minus variable costs, representing what's left after covering the cost of each additional unit sold.
• 🏢 Fixed costs are expenses that do not change with the number of units sold, such as rent, depreciation, and R&D expenditures.
• 🤔 To calculate the break-even point, divide the Fixed Costs by the Contribution Margin per unit.
• 💡 The formula for break-even analysis is Volume Sold * Contribution Margin per Unit = Fixed Costs.
• 📉 If sales are below the break-even point, the business operates at a loss.
• 📈 If sales exceed the break-even point, the business makes a profit.
• 🛠️ Business owners can improve profitability by increasing sales volume, reducing fixed costs, raising unit prices, or lowering variable costs.
• 🌟 The break-even point is dynamic and can be influenced by various business strategies.

Q & A

What is the break-even point in business?

The break-even point is the sales volume where neither profit nor loss is made. It is the point where Contribution Margin $ equals Fixed Cost $.

How is Contribution Margin calculated?

Contribution Margin is calculated as revenue minus variable cost, which means what you sell the product for minus what it costs to make an incremental unit.

What are fixed costs and can you give some examples?

Fixed costs are expenses that do not vary with the number of units sold. Examples include rent, depreciation, and research and development expenditures.

How can the break-even point be represented graphically?

On a graph, the horizontal axis represents the number of units sold, and the vertical axis represents total dollars. The break-even point is where the total revenue line (which includes Contribution Margin) intersects with the total fixed costs line.

What happens if a business sells fewer than the break-even number of units?

If a business sells fewer than the break-even number of units, the Contribution Margin is lower than fixed costs, and the business incurs a loss.

What happens if a business sells more than the break-even number of units?

If a business sells more than the break-even number of units, the Contribution Margin exceeds fixed costs, and the business makes a profit.

How do you calculate the break-even point using a formula?

The break-even point can be calculated as Fixed Costs $ divided by the Contribution Margin per unit. This is the same as saying the volume sold to break-even equals Fixed Costs $ divided by the selling price per unit minus the variable cost per unit.

What should a business owner do with the information about the break-even point?

A business owner can try to sell as many units as possible to increase the volume sold. They can also work on reducing fixed costs, increasing the price per unit, or reducing the variable cost per unit.

Why is it beneficial to work on multiple variables at the same time when considering the break-even point?

Working on all variables (fixed costs, price per unit, variable cost per unit) simultaneously makes the break-even point dynamic instead of static, allowing the business to adapt and improve profitability more effectively.

What is the purpose of the Finance Storyteller YouTube channel?

The Finance Storyteller YouTube channel aims to educate viewers about business, finance, accounting, and investing.

Outlines

00:00

📈 Understanding the Break-Even Point

This paragraph introduces the concept of the break-even point in business, which is the point where total revenue equals total costs, resulting in neither profit nor loss. It explains the break-even point through words, graphs, and formulas. The paragraph defines the break-even point as the sales volume where the Contribution Margin equals Fixed Costs. It also describes the break-even point graphically, with the horizontal axis representing units sold and the vertical axis representing total dollars. The Contribution Margin, which is the revenue minus variable costs, increases with each unit sold, while fixed costs remain constant. Examples of fixed costs include rent, depreciation, and research and development expenditures. The break-even point is illustrated where the lines representing Contribution Margin and Fixed Costs intersect.

Keywords

💡Break-even point

The break-even point is the sales volume at which a business neither makes a profit nor incurs a loss. It is where the total revenue equals total costs. In the video, it is explained as the point where Contribution Margin equals Fixed Costs, indicating a balance between earnings and expenses.

💡Contribution Margin

Contribution Margin is defined as the revenue minus the variable costs associated with producing a product. It represents the amount per unit that contributes to covering fixed costs and generating profit. The video explains this concept using a formula where Contribution Margin per unit helps in determining the break-even point.

💡Fixed Costs

Fixed Costs are expenses that do not change with the level of goods or services produced. Examples include rent, depreciation, and R&D expenditures. In the video, fixed costs are used to illustrate the calculation of the break-even point, with a fixed cost example of $200,000.

💡Variable Costs

Variable Costs vary directly with the production volume. These costs include materials and labor directly involved in producing a product. The video defines variable costs as part of the calculation for Contribution Margin, which is critical in determining the break-even point.

💡Sales Volume

Sales Volume refers to the number of units sold. The break-even analysis in the video focuses on the sales volume needed to cover fixed and variable costs, highlighting that selling more than the break-even volume results in profit.

💡Profitability

Profitability is the ability of a business to earn a profit. The video encourages businesses to use break-even analysis to improve profitability by adjusting factors such as sales volume, fixed costs, and variable costs.

💡Graph

A Graph is used in the video to visually represent the break-even point. It plots the number of units sold on the horizontal axis and total dollars on the vertical axis, showing where the total revenue line intersects with the total cost line at the break-even point.

💡Formula

A Formula is a mathematical expression used to calculate specific values. The video uses formulas to explain how to compute the break-even point by dividing fixed costs by the Contribution Margin per unit, and further illustrates this with specific numbers.

💡Revenue

Revenue is the income generated from sales of goods or services. In the context of the video, it is part of the Contribution Margin calculation, where revenue per unit minus variable costs per unit gives the Contribution Margin.

💡Actionable Steps

Actionable Steps refer to practical measures that can be taken based on the analysis. The video suggests increasing sales volume, reducing fixed costs, increasing price per unit, or reducing variable costs as ways to improve profitability and make the break-even point more dynamic.

Highlights

The break-even point is defined as the sales volume where neither profit nor loss is made.

An alternative definition is where Contribution Margin equals Fixed Cost.

The break-even point is visualized on a graph with units sold on the horizontal axis and total dollars on the vertical axis.

Contribution Margin is calculated as revenue minus variable cost.

Fixed costs are expenses that do not vary with the number of units sold, such as rent and depreciation.

The break-even point is identified where the lines for Contribution Margin and Fixed Costs intersect on the graph.

An example calculation: with $200,000 fixed costs and a $4 Contribution Margin per unit, 50,000 units need to be sold to break even.

If fewer than 50,000 units are sold, the business operates at a loss.

Selling more than 50,000 units results in profit as the Contribution Margin exceeds fixed costs.

The break-even point can be calculated using the formula: volume sold times Contribution Margin per unit equals Fixed Cost.

Another formula for break-even analysis is volume sold equals Fixed Cost divided by Contribution Margin per unit.

The volume sold to break-even can also be calculated as Fixed Cost divided by the selling price minus variable cost per unit.

Using the provided numbers, a business needs $200,000 in Contribution Margin to cover $200,000 in fixed costs at a $4 Contribution Margin per unit.

The business must sell 50,000 units at a $10 selling price and $6 variable cost per unit to break even.

Business owners can use this information to increase sales volume, reduce fixed costs, increase price per unit, or reduce variable costs.

The break-even point can be made dynamic by working on all these variables simultaneously.

The Finance Storyteller YouTube channel offers more insights on business, finance, accounting, and investing.

Transcripts

How to calculate the break-even point for your business?

This break-even analysis video explains the break-even point in words, in graphs, and

in formulas, and encourages you to take various actions in your business to improve profitability.

A common definition of the break-even point is the sales volume where neither profit nor

loss is made.

An alternative way of saying the same thing: the break-even point is the sales volume where

Contribution Margin $ equals Fixed Cost $.

Let’s look at the break-even point on a graph.

On the horizontal axis the number of units sold, on the vertical axis the total dollars.

Contribution Margin $ go up for every unit sold.

Contribution Margin is revenue minus variable cost, what you sell the product for minus

what it costs you to make an incremental unit.

Fixed costs don’t vary with the number of units sold.

Typical examples of fixed cost are rent, depreciation, and research and development expenditures.

The break-even point is right here, where the two lines intersect.

Let’s put some numbers to the example.

If fixed costs are two hundred thousand dollars, and Contribution Margin is $4 per unit, then

the business needs to sell fifty thousand units to break even.

If the business sells fewer than fifty thousand units (the red area), then Contribution Margin

is lower than fixed costs, and the business is loss making.

If the business sells more than fifty thousand units (the green area), then Contribution

Margin is higher than fixed costs, and the business makes a profit.

Let’s do the exact same break-even analysis, but in formulas.

The break-even point is the sales volume where Contribution Margin $ equals Fixed Cost $.

That’s the same as saying that the volume sold times the Contribution Margin per unit equals the Fixed Cost $.

And that’s the same as saying that the volume sold to break-even is equal

to the Fixed Cost $ divided by the Contribution Margin per unit.

And that’s the same as saying that the volume sold to break-even is equal to the Fixed Cost

$ divided by the selling price per unit minus the variable cost per unit.

Let’s fill in the numbers to illustrate.

$200,000 of fixed costs.

The business needs $200,000 in Contribution Margin to cover that $200,000 in fixed costs.

At $4 Contribution Margin per unit ($10 selling price per unit minus $6 variable cost per

unit), the volume sold needs to be 50,000 units.

That’s all very interesting, but what should a business owner do with this information?

The first thing that comes to mind is to try to sell as many units as possible.

Increase the volume sold.

But that’s not the only choice the business owner has.

He or she can also work on reducing the fixed costs, increasing the price per unit, or reducing

the variable cost per unit.

Work on all these variables at the same time, and the break-even point becomes dynamic instead

of static!

Want to learn more about business, finance, accounting and investing?

Then subscribe to the Finance Storyteller YouTube channel!

Thank you.