Thursday, 8 August 2013

Cost Volume Profit Analysis: The Break Even Point, Contribution Margin and the Cost of Things

Break-even (or break even) is the point of balance between making either a profit or a loss. The term originates in finance, but the concept has been applied widely since.

The contribution margin approach to calculate the break-even point (i.e. the point of zero profit or loss) is based on the Cost Volume Profit (CVP) analysis concepts known as contribution margin and contribution margin ratio.

Here the Contribution margin is the difference between the sales and variable costs. When calculated for a single unit, it is called unit contribution margin. Contribution margin ratio is the ratio of contribution margin to sales.

In this method simple formulas are derived from the CVP analysis equation by rearranging the equation and then replacing certain parts with Contribution Margin formulas.


Contribution Margin = Sales Revenue - Variable Expenses

Per Unit Basis the equation is as follows:

Contribution Margin per unit of sales = Sales Revenue per Unit - Variable Expenses per Unit

Contribution Margin - Fixed Costs = Net Operating Profit or Loss

Break even can be calculated onward to the point at which a company's sales are zero - there is no profit or loss:

Break-even in Units = Total Fixed Costs/Contribution Margin per unit

In other words:

Total Revenue = Total Costs

Unit Sale Price x Number of units sold = (TFC + V) Number of Units Sold

TFC is Total Fixed Costs, P is Unit Sale Price, and V is Unit Variable Cost.

BEP in Sales Dollars

Break-even point in dollars can be calculated via:

Break-even Sales Dollars = Price per Unit × Break-even Sales Units

; or

Break-even Sales Dollars = FC ÷ CM Ratio