Break-Even Analysis
The break-even point is the level of sales at which total revenue equals total cost, so the firm makes neither a profit nor a loss. This analysis helps managers make decisions about pricing and sales targets.
Contribution Margin
The contribution margin (contribution per unit) is the selling price per unit less the variable cost per unit. This contribution covers the fixed cost; once fixed cost is fully covered, the firm begins to earn a profit.
Key idea
Contribution per unit = Selling price per unit − Variable cost per unit.
Break-even point (units) = Fixed cost ÷ Contribution per unit.
Break-even point (RM) = Break-even point (units) × Selling price per unit.
Calculation
Example
Murni Company sells one product at RM50 per unit. The variable cost per unit is RM30 and the monthly fixed cost is RM40,000.
- Contribution per unit = 50 − 30 = RM20
- Break-even point (units) = 40,000 ÷ 20 = 2,000 units
- Break-even point (RM) = 2,000 × 50 = RM100,000
At 2,000 units, revenue of RM100,000 equals total cost (variable cost RM60,000 + fixed cost RM40,000), so profit is zero.
Uses
If the firm sells above the break-even point, each extra unit adds RM20 of contribution as profit. Below that point, the firm makes a loss. The analysis is useful for setting sales targets and judging the effect of changes in price or cost.
Margin of Safety
The margin of safety is the amount by which actual or planned sales exceed the break-even sales. It shows how far sales can fall before the firm starts to make a loss. If Murni Company plans to sell 3,000 units while break-even is 2,000 units, the margin of safety is 1,000 units, or one third of planned sales. A wide margin of safety is a sign of lower risk. Break-even analysis, however, assumes that the selling price and the variable cost per unit stay constant and that fixed cost does not change within the range studied, so its results are a useful guide rather than an exact forecast.
Remember
At the break-even point, total contribution equals total fixed cost and profit is zero.