Break-even is one of the most commonly used methods for evaluating a new business enterprise or new product line or manufacturing facility. It’s a tool for analyzing how sales revenue, profit and expenses vary with changes in one of the variables. The break-even point is an equalibrium where sales revenue is equal to costs. At the break-even point, no profits are earned and no losses are incurred. Break-even is a cash flow tool (so we will not consider non-cash expenses in the calculation) that is easy to calculate. It is widely used in production management and by cost and management accountants and can prove useful in determining whether to make an investment in a new plant, a specific piece of equipment or a whole business entity.
One of the drawbacks of the break-even analysis is the assumption that nothing changes. That is, the model assumes that the conditions that were present during the calculation do not change. Of course, everything changes constantly. Sales prices are affected by overall sale volumes and costs of raw materials, labor and transportation costs. The relationship between Therefore, the break-even must be recalculated on a regular basis in order to keep the information relevant and useful.
In order to compute the break-even point, we need to know the following variables:
- Annual Sales Revenue
- Gross Profit Margin
- Operating Expenses (less depreciation)
- Annual Debt Service
With these figures in hand, we can caluate the various components of break-even.
Break-Even Sales: (Operating Expenses + Annual Debt Service)
Gross Pofit Margin %
Break-Even Gross Margin: (Operating Expenses + Annual Debt Service)
Sales
Break-Even Operating Exp.: Sales × Gross Pofit Margin %
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