A break-even analysis is used to assess expected profitability of a company or a single product. It helps you determine at what point revenues and expenditures are equal.
Break-even is usually expressed in terms of the number of units you’ll need to sell or how much revenue you’ll need to generate.
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 variety 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 units, 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.
For more detail on the subject, read: What Is Break Even Analysis?