A technique commonly used to assess expected profitability of a company or a single product. The process determines at what point revenues equal expenditures based on fixed and variable. Breakeven is usually expressed in terms of the number of units sold or in total revenue. The break-even analysis is a standard financial analysis that measures general risk for a company by showing the sales level needed to cover both fixed and variable costs. That level of sales is called the break-even point, which can be stated as either unit sales volume or sales as dollar (or other currency) sales. The break-even analysis uses three assumptions to determine a break-even point: fixed costs, variable costs, and unit price. Fixed costs and variable costs are both included in this glossary, and unit price is the average revenue per unit of sales. The formula for break-even point in sales amount is: =fixed costs/(1-(Unit Variable Cost/Unit Price)) The break-even analysis is often confused with payback period (also in this glossary), because many people interpret breaking even as paying back the initial investment. However, this is not what the break-even analysis actually does. Despite the common and more general use of the term “break even,” the financial analysis has an exact definition as explained above. One important disadvantage of the break-even analysis is that it requires estimating a single per-unit variable cost, and a single per-unit price or revenue, for the entire business. That is a hard concept to estimate in a normal business that has a collection of products or services to sell. Another problem that comes up with break-even is its preference for talking about sales and variable cost of sales in units. Many businesses, especially service businesses, don’t think of sales in unit, but rather as sales in money. In those cases, the break-even analysis should think of the dollar as the unit, and state variable costs per unit as variable costs per dollar of sales.

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Tim BerryTim Berry
Tim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.