Breakeven Analysis
The Definition
“The level of sales (by volume or selling price) at which sales equal costs (no profit, but no loss either).”
This means that if your total costs for running your business for, say, one month was £5000 and you sold carpets at £1000 each: you would need to sell 5 carpets, or put another way, £5000 worth of carpets. (Simple? Well it’s not that straightforward).
A Scenario
A company called XYZ Ltd is planning to bring to market a business software program.
- The ‘fixed cost’ of research and development is £25,000.
- And the cost of production and distribution (known as ‘variable costs’) being £8.00 per ‘unit’.
- The research has shown that the market-place puts the software retail price at £26 each.
Summary of Costs
| Research £25,000 | Variable Cost £8 each | Retail Price £26 each |
The Formula
First you find the ‘contribution‘ figure: this is the difference between the variable cost (£8) and the selling price (£26), being £18.
Then, find the number of units that have to be sold to cover the ‘fixed costs’ (being £25,000), then divide by £18 (the contribution) which equals 1389 units that has to be sold to breakeven.
|
Selling Price |
£26 per unit |
|---|---|
|
Less: Variable Cost |
£8 per unit |
|
= Contribution of £18 per unit |
|
|
Divide Fixed Costs |
£25,000 |
|
By Contribution |
£18 |
|
= Units to sell to break even = 1389 Units |
Analysis
Once you have established the volume of sales (1389) you need to consider the viability of reaching this most basic target. Remember, this figure does not include profit, be that for inward or outward distribution. What you could discover is that the order you already have for 1500 units will be profitable. You may decide to increase or decrease your price based on the results to make you more competitive.
What Profit is Achieved?
Contribution (£18) times (x) expected sales (1500) less (-) fixed costs (£25,000) equals profit of (=) £2,000.
i.e. £18 x 1500 – £25,000 = £2,000
What are Fixed Costs ?
Costs that exist if you made one or a hundred items i.e. full rent is paid regardless of output – Rent, Rates, Lease, Gas, Electric, Wages (support staff)…
What are Variable Costs ?
Costs that can increase or decrease depending on the volume of units made and sold – Materials, Direct Wages (actual labour force), Delivery, Post…
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