Break-Even Analysis
A financial tool that identifies the sales volume at which total revenues equal total costs, yielding zero profit or loss.
What is Break-Even Analysis?
Break-even analysis determines the point at which a business's total revenue equals its total costs — the break-even point (BEP) — so that neither profit nor loss is generated. The break-even point in units equals fixed costs divided by the contribution margin per unit (selling price minus variable cost per unit). In dollars, BEP equals fixed costs divided by the contribution margin ratio. Break-even analysis is essential for pricing decisions, new product launches, and capacity planning. It also allows businesses to calculate the margin of safety — how much sales can fall before losses occur. Limitations include the assumption that fixed costs remain truly fixed and that variable costs are perfectly linear across all output levels.
Example
A software company has $500,000 in fixed costs per year and sells subscriptions at $100 each with a variable cost of $20 per subscription. The contribution margin is $80 per unit. Break-even point = $500,000 ÷ $80 = 6,250 subscriptions. Above that level, every additional subscription generates $80 of profit.