What Is the Break-Even Analysis?
Break-even analysis is used for estimating the number of units that must be sold in order to avoid losing an initial investment.
Why Is it Important?
- Many businesses require financing. Lenders feel most comfortable extending credit when they can estimate the number of units that must be sold.
Formula(s) to Calculate Break-Even Analysis
- BREAK EVEN IN UNITS = FIXED COSTS / (PRICE - VARIABLE COSTS)
- The formula typically contains an assumption that fixed prices cannot be recouped. In reality, many fixed costs, such as factories, vehicles, and licenses can be resold to others.
- The formula is, by definition, forward-looking. As a result, users are forced to make assumptions about consumer demand and willingness to pay. Often these assumptions can be wildly inaccurate.
- Many users of the formula do not fully account for all variable and fixed costs. As a result, they may wildly underestimate the number of units that must be sold to truly break even.
- Vendors can often chose from a variety of methods of production that require different capital investments. Often, production methods that require higher fixed investment lead to lower variable costs per unit manufactured. For this reason, vendors may have to run several different break-even analyses.
Additional Business & Financial Calculators Available