View FREE Lessons!
Definition of Break-Even:
in production of a good or service occurs at the point where output covers the variable and fixed costs of producing the good or service. There is neither a profit nor a loss at break-even.
A business achieves break-even when its output is sufficient to cover its costs. Lower production levels result in a loss; but profits increase at a rapid rate as production is increased beyond the break-even point. Break-even analysis is helpful in identifying how many units must be sold to earn a profit. Business managers should ask if the derived break-even is achievable, given the competition and size of the market?
Management must identify three variables to calculate its break-even point - price, fixed costs, and variable costs. Fixed costs are not directly influenced by how much of a good or service is produced. Examples of fixed costs include: rent, a mortgage payment, insurance payments, and salaries of essential personnel. Fixed costs are frequently referred to as overhead. Variable costs are directly influenced by how much of a good or service is produced. Examples of variable costs include: raw materials, labor directly involved in the production process, packaging costs and transaction fees.
The break-even formula is:
Break Even # Units = Fixed Cost / (Price – Variable Unit Cost)
Assume you are considering opening a small ice cream parlor. After doing some research you estimate your total monthly fixed expense would equal $1,100. This includes rent, office utilities, and other overhead expenses. You estimate your variable cost at $1.20 per scoop. This includes the cost of ice cream, cups, napkins, and labor. You plan to charge $2.50 per scoop. Your break-even would equal 847 scoops. The calculation is shown below:
On the graph that the total cost and total revenue curves intersect at the break-even point. Once break-even is achieved every sold scoop sold would add $1.30 to your profit.
Break-even # Units = $1,100/ ($2.50-$1.20)
Dig Deeper With These Free Lessons:
Output and Profit Maximization
Fundamental Economic Assumptions
Factors of Production - The Required Inputs of Every Business
Marginal Analysis - How Decisions Are Made